Introduction Imagine a world when the gasoline or oil reserves would run out. What would things be like? Perhaps the quickest image to picture is the one that the movie, Mad Max would want us to see. Barbarians running across a barren landscape searching for nothing but oil. Although the movie may have taken the matter too extremely, it does present an interesting point to ponder upon: oil is a necessity. In the 1700-1800s, oil was used primarily for heating and lighting purposes only, nothing more, and nothing less. However, when Karl Benz invented the internal combustion engine in 1898, the world would change forever. From merely a heating and lighting fuel, petroleum has become a major factor in about every industry today from power production to diaper making. Petroleum has become a major gambling chip in today's world power struggle. Though one would argue that the oil industry has lost much of its steam when compared to say more high-tech ventures such as consumer electronics, oil still holds a long-term value, which cannot be put aside. Our world runs on petroleum, and this is a fact one would learn to accept; though it wasn't as profitable as it used to be. In this research paper, the main thrust would be to analyze the petroleum industry from a broad worldwide perspective before going down specifically to the Philippine setting. Hopefully, with this view, the position of the Philippines in the world market could be seen more clearly and could very well help answer several questions to topics such as oil price increase and so forth. Whenever possible, this paper will focus on the consumer applications of petroleum products such as pump gasoline. In addition, this paper will supply some historical information that it would helpful in analyzing the current situation with the one year ago. Oil is What Makes The World Go Round Each time Shell Velocity is pumped into a Honda Civic, hundreds or probably even thousands of people benefit. Oil is the world's biggest single source of fuel. In fact, in 1996 alone more than 71.7 million barrels per day of oil was used. Of course, if one were to think about the present world, it wouldn't be surprising. Every industry imaginable runs on these fossilized remains of prehistoric creatures. In fact, even clean energy such as electric- powered generators or cars still have to run on oil indirectly because electricity is generated using diesel turbine power plants. All in all, the world runs on oil. However, there is no cause for alarm if one were to think that we are beginning to loose oil reserves. In fact, Oil and Petroleum Exporting Countries or OPEC member nations predict that currently known supply would last for around 80 years, while non-OPEC member nations' reserves would give an additional 20 more years. Of course, if more oil fields are developed and the current supply is increased, then this prediction is sure to change. Currently, the world has a reserve of 1,047,200 million barrels of cruel oil; all of these are proven reserves. Breaking this figure down, the country with the largest oil reserve is Saudi Arabia with 261,444 million barrels followed by Iraq at 112,000 and the United Arab Emirates at 97,800. However, oil production tells a different story. Although middle-east countries have the upper hand in proven oil reserves, when it comes to oil production, the United States of America comes in at second with a production of 6.5 million barrels of oil and Iran at 3.6 million. Surprisingly, China has become a key player as well with 3.2 million barrels of oil. Contrary to popular thought, oil production will increase in the foreseeable future from the current count of 70 million barrels to around 100 million barrels a day. This is despite the fact that OPEC sees that the oil's share in the worldwide energy market will fall by almost 40 percent during the same period. Although the petroleum industry is surely a good industry to venture in, one has to consider the large up-front capitalization requirement. Oil exploration alone could cost tens or hundreds of billions of dollars. The true value of oil exploration is dependent on the geographical location of the exploration site and how large the oil field would be. Though new technologies such as three-dimensional seismic techniques are being used to further help in the exploration of this commodity, OPEC estimates that the up-front capital requirement for oil development is still $100 billion. According to OPEC, this $100 billion is one of the lowest figures in the world because OPEC member countries have oil reserves in reasonably accessible locations. Pricing the Precious Commodity How precious is oil becoming to be in today's world? The price of oil is very important to the world economy. Oil accounts for roughly 40 percent of the world's energy source. The world trade in fuel represents 7 percent of the total world merchandise and a third of the world trade in primary products. The uses of oil now extend beyond energy and heating requirements. Oil is fundamental to the welfare of the industrialized world and it is a major component of the farming industry as well. The price of oil is reflected in most of the things we do. It impacts on the price of transport, the cost of goods and services, and the availability of many products, including food, water and shelter. If oil prices are too high, then these goods and services become more expensive and economies experience inflation. Alternative forms of energy would also become more cost-competitive, but oil producers would eventually increase their supplies and prices would come back down. If oil prices are too low, consumers would waste this non-renewable resource, investors would not be attracted to the industry and oil producers would suffer especially the developing countries that produce oil, such as the OPEC member countries. If prices were too low, supplies would eventually fall until there was a price shock-leading back to inflation. Oil prices that are too high or too low are clearly unhelpful for oil producers, oil consumers and the world at large. That is why OPEC makes quite sure that the market is not under-supplied with oil, forcing prices to go excessively high, and also that the market is not over-supplied so that prices go too low. It also speaks to other oil producers to encourage them to avoid over-supplying the market. It is also why OPEC talks to oil consumers to encourage them to adopt fair and equitable policies that do not discriminate against oil. We would all suffer without steady supplies of oil at stable, reasonable prices. The Controlling Factor: OPEC Ever since the world started using oil as a major source for fuel industry, oil has become part of the limelight. When demand reached a global scale, countries started to figure out ways to increase the revenues that this industry could generate. In September 14, 1960 the OPEC was formed. OPEC, is a voluntary inter-governmental organization that coordinates and unifies the petroleum policies of its member countries, which account for a forty-percent share of the world total production and sixty percent of the world's export total. Currently, OPEC has eleven member nations from the original number of five. The only Asian country to be part of OPEC is Indonesia. OPEC works by holding conferences and meetings with the heads of delegation of its member nations to coordinate and unify the petroleum prices to promote stability and prosperity. OPEC prices their oil by considering the current situation plus looking into forecasts of market fundamentals such as economic growth rates and petroleum demand and supply scenarios. However, not all nations could become members of OPEC. A certain quota is required for a country to join this elite group of nations. OPEC does this because they have to monitor the petroleum consumption. The member nations must be ready to increase or decrease oil quotas to meet new demands; thus this fail- safe mechanism is one way to enforce OPEC's demands. Nonetheless, OPEC stresses that they do not control the oil market. OPEC mainly seeks 'stability and endeavors to deliver steady supply of oil to consumers worldwide'. In fact, OPEC press releases statements says that the changes their member countries bring due to changes in oil prices is minimal when passed on to the consumer mainly because local government taxes affect the prices more than the prices of the raw materials. OPEC says that in some countries, the taxes account for 70 percent of the final price total for consumer pump gasoline. Nonetheless, OPEC believes that they have a sort of control on the industry. In the OPEC Statute, it declares that OPEC is dedicated to providing steady supply to consumers at reasonable prices. In fact, for many years OPEC has done its duty well keeping the prices of cruel oil in the world market at relatively stable levels. However, OPEC is still cautious about factors that are beyond their control, which can disrupt this stability. Among those mentioned is taxation, which again constitutes a large amount of the market value the consumers pay for gasoline. One surprisingly question is why do some oil-rich nations such as the United States still resort to importing oil rather than to use their natural resources? In 1996 for instance, the United States consumed around 17 barrels of oil, importing 46 percent of their needs or 7.7 million barrels. According to the OPEC documents, this is beneficial to more than one party and if the United States were to stop in the importation of oil, it could affect the welfare of its people. Without going into much detail, the report states that roughly half of those responsible for refining oil within the US would loose their jobs, prices would skyrocket and all of the oil importers would find themselves out of a job. The regulating power of OPEC is clearly evident in our world today. In fact, even countries such as the United States of America have little choice but to follow the OPEC listed price. In recent developments, world crude prices is expected to increase to the level of $30 a barrel from the current $24. President Clinton even threatened OPEC that the US would use its oil reserves to bring the prices of crude oil down if OPEC continues with this over inflation of prices. At this point, OPEC is still holding their own ground to this new oil price. If countries as powerful as the US have no recourse, but to be controlled by OPEC, what about the Philippine situation? Since the Philippine oil consumption is less than 1 percent when compared worldwide, we cannot in anyway influence the market price, which is constantly bidding involving tremendous volumes where we don't count at all. The only good news is that the price quoted by the US at $30 per barrel is the one in the New York Mercantile Exchange. However, according to energy secretary Mario Tiaoqui, this price is normally several dollars more than the composite price of the oil imported into the Philippines. Starting From the Beginning Contrary to popular belief, the downstream oil industry was not regulated at the start. From the 1950s to the 1970s, there existed some form of ompetition among six major oil companies: Shell, Caltex, Esso, Mobil, Filoil and Getty. However, the oil crisis in the 1970s forced the government to regulate the Philippine oil industry. This is because the government saw this as the solution to try to protect the consumer from as much as 1,700 percent increase in world crude prices. The increase in prices was due to the OPEC member nations' decision after there was some speculation that the world had only 20-30 years of oil reserves, which was running out. In the end however, this story was proven entirely untrue. However, the damage was already done. The Philippine National Oil Company or PNOC was also established in 1973 to supposedly ensure adequate and continuous supply of oil, as well as break the control of foreigners in the oil industry. During the time of oil price regulation, the government determined the appropriate level of oil prices based on three considerations: 1.) Changes in the landed cost of crude (in pesos) 2.) A reasonable and fair return for the oil companies based on the return- on-rate base formula applied to public utilities, with a cap of 12 percent. The balance remaining in the Oil Price Stabilization Fund (OPSF), the buffer fund that served to insulate the public from abrupt or frequent oil price changes. Later, the PNOC established Petron Corporation as its marketing arm. Using PNOC's refining plant, the government sold petroleum products to the consumers through Petron. The period of regulation saw the oil companies-which, by 1985 only numbered three (Petron, Shell and Caltex)-having to petition to the Energy Regulatory Board or ERB to increase oil prices. The ERB was also required to conduct public hearings to determine the validity or the price adjustments. This meant that the oil companies could not make price increases on their own, and would even have to rollback prices if warranted. Since their voices have not been heard, most of the oil firms operating in the country started to bow out due to low profitability and huge losses generated by the government's tough regulation program. Esso and Filoil pulled out as early as 1973, while Getty followed suit in 1980 and Mobil in 1983. It is no surprise therefore that as early as the late 1980s, the oil firms have been repeatedly calling the government to deregulate the oil industry. Still Room for Improvement: The Current Philippine Oil Industry The oil industry in general is composed of two sectors: the upstream and downstream activities. Upstream industries include the search for oil under land surfaces or under bodies of water, developing these sources to produce commercial quantities of oil. In short, this portion is basically crude oil mining. Meanwhile, the downstream oil industry involves a wide range of activities, which provide the link between the oil suppliers and the consumer of petroleum products. It could be defined further as the 'business of importing, exporting, re-exporting, processing, refining, storing, distributing, marketing and / or selling crude oil, gasoline, diesel and all other petroleum and crude oil products. Looking at the international perspective, the Philippines' current performance is rather insignificant compared to the oil production and consumption of other countries. Information gathered by the Department of Energy says that the Philippines produced only 4,000 barrels of oil per day (bbl/d) compared to India's 764 thousand bb/d and Thailand's 123 thousand bbl/d. Of course, this small production value cannot handle the country's needs, which could reach an average of 340 thousand bbl/d. Thus, the Philippines has to rely on oil imports to makes sure industry would run normally. The report added that the Philippine's demand for cruel oil would remain fairly constant in the next few years, however the demand for cruel oil for use in government-run power plants would lessen as a result of the government's drive to retire the aging oil-fired electric power plants. Though there is no significant current crude oil production, some exploration is taking place in the hope of lessening the country's oil importation needs. One such exploration, the SOCDET or Sydney Oil Company Drilling and Exploration is currently conducting exploration in Palawan, where with the help of high technology equipment, it would be possible to find new oil deposits. One of the giant oil companies in the Philippines, Royal Dutch-Shell has also been doing exploration in the Philippines for quite some time now. Aside from oil exploration and research, the Philippine oil industry also includes the downstream oil firms, which mainly focus on the distribution and marketing of imported processed oil, while some have contented themselves by supplying oil by-products and other finished goods as a result of processing oil.The industry has a huge array of products ranging from the consumer pump gasoline (unleaded, super, diesel) to aviation fuel, liquefied-petroleum gas or LPG and lubricant products. The product diversity of each oil firm depends on their availability of facilities within the country. For instance, Shell, Caltex and Petron have the biggest array of products in the country gathering almost all range of products from lubricants to special fuels. In fact, Shell and Petron are close to signing a deal with Napocor to be the sole suppliers of diesel for the country's energy requirements. Whereas Caltex has contracts with some airlines to be the sole supplier of aviation fuel for them. Other firms such as UniOil and Flying V are more limited to the consumer pump gasoline (i.e. gasoline stations). On the other hand, Mobil, which used to have a strong Philippine presence in the 1970s decided to focus on lubricant and plastic film materials rather than going back to the direct line consumer pump gasoline. The pricing of petroleum products here in the Philippines is at par with most of its Asian neighbors. In fact, when Merrill-Lynch did a study on the prices of petroleum products in the Asian region in the first quarter of 1999, the Philippines was ranked with a reasonable price for products such as unleaded gasoline and diesel. Gasoline and diesel prices increased in January of 1999 by 9.5 and 11 percent respectively. By the analysis of Merrill-Lynch, this increase revealed that the Philippines was more subject to the changes of the world price of crude oil compared to other Asian nations, which have a tendency to depreciate the pricing. Calculations done by the big three oil firms indicate that downstream oil products are priced based on the world price of crude oil. For every $1 increase in crude oil cost, production cost increases by 27 centavos per liter. Similarly, for every peso fall versus the dollar, the cost of production goes up by 12 centavos per liter. With OPEC wanting to raise prices to $US 30 barrel, even countries such as the US are beginning to feel the pinch. However, according to Mario Tiaoqui, the Philippine's composite price for imported crude oil still stand at an average of $24.40 per barrel, compared to $25.00 the week before. Tiaoqui hopes that this trend is downward, which mean prices of oil products here in the Philippines could remain cheaper or at least hold their own ground for the next couple of months. Strength Lies in Money and Diversity The diversity of oil products is a big strength in this highly competitive business. In fact, Shell, Caltex and Petron have a combined dominating share of close to 93 percent of the total domestic needs. Being leaders in the industry, the so-called big three of the oil industry have used a lot of their capitalization for marketing, promo and diversification needs in hope that this will garner them more share in the local market. Since the prices of consumer pump gasoline has been relatively the same for these three competitors, these three have been trying to market new products or create new gimmicks to attract customers. Although their products are relatively the same, these three corporations have been trying to acquire a new corporate image, which distinguishes one from the others. For instance, Shell has been focusing on their team-up with the highly successful Ferrari formula one team to promote their unleaded and Velocity gasoline line-ups. On the other hand, Caltex shifted their promotions from a 'service oriented, pang-masa gasoline station and went to a high-performance Filipino image using actor Cesar Montano. Whereas Petron concentrated on presenting service, Filipino style. With the recent deregulation of the downstream oil industry and the privatization of Petron, the future is looking brighter for healthy competition in the country. Though establishing a good name would take time compared to if one is already an industry leader, once the distribution and selling network have been finalized, then it would be quite easy for anyone to enter the market. Oil companies have been giving away franchises left and right in the recent years making gasoline stations sprout out like weeds at almost every corner. The downstream oil deregulation law was one of the last steps of the Philippines to free itself from IMF control. When President Fidel Ramos signed the bill into a law, it removed the twenty-year hold of the government in oil price control. This liberalization introduced competition into the downstream sector. The bill instituted a three-percent tariff duty on imported crude and refined petroleum products. The Act also eliminated the requirement that all downstream operations maintain 40-day inventory, which previously was viewed a barrier to new entrants to the market. President Fidel Ramos argued that the oil deregulation law dismantles the monopoly of the Big Three. The Supreme Court added, "it cannot be denied that our downstream oil industry is operated by an oligopoly, a foreign oligopoly at that...Petron, Shell and Caltex stand as the only major players in the oil market. All other players belong to the Lilliputian league." Under the new oil deregulation law however, oil companies are able to set the prices for refined products. This helped the gasoline industry to rebound after the Asian financial crisis in 1997 where they could not raise prices to cover their huge losses. However, at this point, the government still maintains a sort of regulation for socially sensitive products such as kerosene. The deregulation of the downstream oil industry and consequent rise in the number of gasoline firms in the country is a good indication that there is healthy competition in the industry. However, in the long run, it seems that things did not turn out so well. The World is Not Enough and Size Does Matter Because of the cutthroat image of the consumer division of gasoline companies, franchise owners are actually the ones feeling the pinch when the competition gets too much. As early as 1998, some franchise owners have been complaining that the huge gasoline companies have been not caring for them, but are just reaping their rewards. How is this so? The Philippine Daily Inquirer ran an article last year stating the sad state of gasoline franchising in the country. The report gave a rather simple, but very realistic scenario involving two gas stations owned by the same company but run by different franchises. Say on the northbound side of Marcos highway, Johnny thought about putting up a Shell gasoline station because he thought there was a demand for it in the area. Going to Shell Philippines Inc., he got him a franchise and built the gas station. Cars started pouring in and so did the money and he became happy. However, a few months later another person puts up another Shell station just one kilometer before the Johnny's station. Of course, because of the nearer location, Johnny started to loose some customers. When he started to loose money he decided to close shop and try another business instead. These kinds of stories actually do happen in everyday life here in the Philippines. Most franchise owners have been complaining that the gasoline station promo materials such as 'scratch-to-win' contests are not supplied free of charge by the oil companies but have to come from the pockets of the franchise owners. In short, whether the station is doing well or not, the big gasoline companies will have a fixed cut in the earnings. If there are promos, the franchisers will have to pay for them. If the business turns sour because of another station a few kilometers away hogging the consumers, the gasoline companies will not care. At the same time the entrance of a new competitor at the highest level would be close to impossible here in the Philippines for mainly one reason: the high capitalization requirement needed to venture into this kind of business. The Philippine oil market, although considered to be a growing user of oil products, is still insignificant compared to other Asian countries. In the southeast region alone the Philippines cannot compare its oil consumption of 350 thousand barrels per day when put side-by-side with the nearly twice the size of 740 thousand barrels per day usage of Thailand. This is quite urprising when one considers the fact that the Philippine is bigger in land area and population compared to Thailand. One probable factor for the big difference in oil consumption in 1997 is that Thailand's GDP is around twice that of the Philippines indicating that there is was an industry boom in Thailand requiring a huge amount of oil. Since gasoline is an inelastic commodity, it is produced in mass quantities at a very low price. The facilities for manufacturing gasoline are tremendous and the manpower requirement is large. As mentioned above, the minimum capital requirement is around $100 billion for oil exploration and development. Due to the large amount of investment needed, this could deter entry by forcing the new entrant to come in at large scale and enter a risky environment from the competitors. Thus, there are only three main oil exploration and development companies here in the Philippines: Caltex, Shell and Petron. The largest oil refinery here in the Philippines is Petron's refinery at Limay, Bataan. This refinery has a total capacity of 180,000 bbl/d. This is followed by Shell's 137,000 bbl/d facility at Tabango and the 72,000 bbl/d Caltex facility in Batangas. The overall performance of these refineries is at 80 percent, and thus there is no demand for a new refinery station as of the moment. However, the Department of Energy has projected the current usage of oil until the year 2009 (that's ten years after the Department of Energy's report was published) and found out that the Philippines, by the year 2004 needs a new refinery station. The reason for this is that the localized oil supply will only contribute a small portion compared to the overall demand of the country. With this rapid increase in domestic oil requirements, the country's complete dependence on imported oil will be inevitable. The government, wanting to keep a sort of safe ground would like to maintain at least a 5 percent share from domestic refineries rather than seeing 100 percent coming from imported sources. If refining oil is not the best way to enter the oil industry in the Philippines, the best would be to be part of the downstream oil market. However, in choosing the downstream market is much like the analogy of choosing between the frying pan or the fire. The meaning of downstream oil market is mainly to act as a sort of distributor of gasoline and oil products in the Philippines. Rather than putting up huge refineries in the country, the best would be to import processed oil and market them here as a commodity. This is further helped with the downstream oil industry deregulation that started in February of 1998. In fact, because of the oil deregulation, there has been positive response and 53 new firms have been participating in various activities of the downstream oil industry, TOTAL, Flying V and UniOil to name a few. These 53 firms have set-up 112 service stations across the nation as well as storage and distribution facilities, which have intensified competition in the industry. Although the big three still maintain a dominant share of the market, they are starting to face stiffer competition from the new firms, getting 8.1 percent of the total market in first half of 1999. However, it seems that the deregulation, although has brought out an increased number of players in the market, cannot assure the accessibility of the petroleum products. The increase in the number of industry players does not mean that the companies have been dispersed nationwide. Looking their area of operations, it becomes quite clear that the new oil firms have opted to invest in areas that are either urbanized or relatively developed. The availability of oil in far-flung areas has yet to be achieved under deregulation. The ARMM and Region V, comprising Bicol have the highest poverty incidence as of 1997, at 60.0 percent and 55.1 percent respectively and thus are not prioritized by the new industry players as they establish themselves in the domestic market. Conclusively, it is apparent that they have opted to invest in areas where the poverty incidence is lower such as the National Capital Region, whose poverty level is at 8.0 percent. The effect of deregulation is much more than just the distribution of petroleum products in the country. The more concrete effect of oil deregulation may be seen in the increased price of petroleum products. However, could this price increase be justified by the increase in world crude prices or are these signs that the dominant three oil firms are still in control of the so-called free market oil industry. The only way to find out is to first analyze the key players in the industry, mainly the so-called big three: Petron, Shell and Caltex. On the Gambling Table There are three key players in the oil industry in the Philippines. These three, as stated earlier, have a combined market share of 93 percent. The biggest of these three is Petron Corporation. Today, Petron Corporation supplies more than 40 percent of the Philippines' oil needs. It provides around one-fourth of the energy used to generate electricity in the country, one-third of the fuel to power trucks, buses, jeepneys and cars, and close to half of the oil consumed in manufacturing and other industries. Aside from its huge refinery in Limay, Bataan, Petron maintains bulk plants and service stations to carry a broad range of products and services that include various kinds of fuels and automotive lubricating oils. Aside from this main line, Petron also offers a wide range of industrial and marine lubricating oils, greases, asphalt and various after market and special products. First established in 1973 as the Philippine National Oil Company's marketing arm, Petron Corporation is now owned jointly by the PNOC, which has a 40 percent share alongside with Saudi Arabian company, Aramco. The remaining 20 percent is owned by more than 200,000 minority share holders. Aided by a stabilizing peso and a decline in world crude oil prices, Petron's finances substantially reverted back to health by the end of 1998. Aside from the reasons given above, Petron changed corporate strategy to reduce their operating expenses by cost optimization measures. In 1998, Petron ended with a health net income of 3.7 billion pesos compared to the previous year's net loss of 631 million. Although revenues dropped three percent 1998, this year also saw a decline in sales volume by more than six percent. However, this did little affect market share as the remaining two gasoline companies still pegged a 42 percent share. Petron's marketing principles are guided by customer intimacy to boost their presence in the retail and reseller market. With this in mind, Petron began re-imaging their service stations with new designs and service standards such as their own convenience store known as Treats. 64 new service stations added to the total count of 1,116 maintaining Petron's lead in network size. Apart from improving retail facilities, Petron has introduced new products for motorists. This product differentiation strategy brought about products such as Petron Diesel Max as well as Adgas, both promising added power / reduced emissions for the welfare of the environment. Though Petron is the largest of the three to have a presence in the local scene, both Shell and Caltex are huge multi-nation corporations whose operations span more than 40 countries worldwide. Using their large international based capital, both of these groups decided to enter the Philippine market. Caltex strengthened its position in the local market by intensifying its campaign in 1981. However, even before this time Caltex already had a strong Asian presence in Singapore, Hong Kong and Australia. Jointly owned by Texaco and Chevron, Caltex was formed more than 63 years ago. Caltex refines crude oil and markets petroleum and convenience products through subsidiaries and affiliates. Currently, Caltex is involved in all aspects of the downstream business: refinery, distribution, shipping, storage, marketing, supply and trading operations. It currently operates in more than 60 countries worldwide with major operations in Korea, Japan (petrochemicals), Australia, Thailand, the Philippines, Singapore (exploration and development) and South Africa. Caltex's worldwide revenue is $17.17 billion in 1998, while total income is $183 million for the same period. Equity refining capacity of 978,000 barrels per day. Caltex's sales of crude oil and petroleum products were 1.5 million barrels per day in 1998. Established in 1921, Caltex Philippines now markets a full range of petroleum products such as premium / unleaded pump gasoline, diesel, kerosene, LPG and more than 100 brands of lubricating oils. Caltex runs a 72,000 bbl/d refinery at San Pascual, Batangas; two terminals at Pandacan, Manila and at Lapu-Lapu City in Cebu, and 43 oil depots, a lubricating oil blending plant, a grease manufacturing plant and close to 1,000 service stations. Caltex Philippines currently employs close to a thousand people to maintain their daily operating needs. Sales of Caltex Philippines amounted to $1,288.4 million that's a 0.01 percent increase compared to last fiscal year. Holding a share of 30.9 percent is the local subsidiary of the British- Dutch company, Shell Pilipinas corporation. Being middle between the two players, Shell has enjoyed tremendous success in the Philippine industry starting 1914 when they first put up shop locally. Now with the second largest oil refinery plant in the Philippines with a maximum capacity of 155,000 bbl/d, Shell's place in the Philippine market is secure in almost every way. With more than 1,000 service station across the country as well as having specialized products such as aviation fuel, the world's second largest oil and gas group is keep its ground in terms of market share in the Philippines. Aside from pump gasoline and lubricants, Shell also distributes LPG under the brand name Shellane. However, despite being the longest oil company to stay in the Philippines, Shell is not immune to the effects to the infancy of the deregulated market. In fact, as part of its cost cutting measures, Pilipinas Shell had little choice but to shell their Makati headquarters as well as shutdown auxiliary services such as their Internet web site. With the deregulated market, Pilipinas Shell is beginning to see a huge difference in market behavior then and now. With this in mind, Shell has begun to intensify their marketing campaign in the hopes of differentiating their product from the competitors to increase their market share. As part of their marketing and promotions, Shell centered their image on the more upscale, performance-related market. By highlighting their team-up with the Italian racing team, Ferrari, Shell has been trying to push an image of passion and excellence in fuel mixture rather than being service-oriented as what Petron has been focusing on. Aside from their marketing campaign with Ferrari, Shell has also introduced new benchmark products such as the high-octane unleaded gasoline, Shell Velocity. Currently available in more than 100 Shell stations nationwide, the Shell Velocity is targeted more at those who are wishing to get more power our of their cars, and hence performance boosters added into this new fuel. Although this might have helped even in the slightest bit, Pilipinas Shell did not do so well in the past few years and it predicts that this slide may continue unless they adjust their pump gasoline prices to match those of the world market. Smaller companies such as TOTAL Philippines, a subsidiary of the French company, TOTAL is only starting here in the Philippines. However, they have devised a long-term seven-year plan in order to turn their investments into profits. Starting out with an operating budget of P800 million in 1997, TOTAL has invested close to P1.5 billion in the distribution and marketing of petroleum products. This large investment is still beside the fact that TOTAL imports all of its oil from other refinery stations elsewhere. Currently, it has an oil depot in Bataan and is building a new one in Batangas. TOTAL also has plans to expand to the LPG market in 2002 when its new facilities would be completed. More service stations are also planned in the coming year to add to the current salvo of five. Around P200 million has already been set aside for their service station expansion program. Other small players that are included in the 8 percent are the following: Coastal Petroleum, PTT of Thailand, Liquigaz, UniOil Petroleum, Eastern Petroleum and Flying V. Building Up a Defense The Philippine oil industry is nothing short of stable. Since the market share that the Philippines has is insignificant in the worldview, price can go up or go down all depending on the world price of crude oil. In other words, in terms of pricing, the oil firms here have little power over their suppliers. The main defense of the oil firms in the Philippines is to consider one of two options: to increase their sales dramatically and still maintain the same price levels for the consumers or increase price to compensate for the lack of demand for their products. Since the Philippine market is as little as 1 percent of the global piece of the oil pie, the best recourse for the oil firms is to increase their prices. However, because of the fierce competition brought about by the oil downstream deregulation law, the oil companies are stuck between a rock and a hard place. If they choose to increase prices, they might be massacred by their competitors, but if they choose not to increase their prices, they might close down due to lack of funds. With this kind of situation, the petroleum industry is clearly not a good situation to be in, especially if the current capitalization is not so high. Thus it would be hard to set-up a good defense for the petroleum industry, and because of its high capitalization requirement and high-technology costs, there exists high entry and exit barriers. All in all, the current oil industry is undergoing a cutthroat competition game from market share rather than expanding to newer ground. This is true for the Philippine setting since oil demand has not dramatically increased in the past few years, and with the advent of oil deregulation, more and more players find themselves mixing it up with the big guns of the industry. The Issue of Profitability It is commonly believed that oil companies are among the most profitable companies in the Philippines, and that every time there is an increase in the price of oil, these companies enjoy a windfall that goes straight to their bottom line. It is easy to understand how these misconceptions might arise. Oil companies sell huge volumes of petroleum daily, and the public needs to use these products whether they like it or not. With so much power over the daily lives of the people, it is not surprising that oil companies are suspected of overpricing and profiteering. However, the truth is that oil companies have never enjoyed more than very modest returns on their investments. During the years when the oil industry was regulated, the government kept a tight rein on the oil companies' margins. Even if the ceiling set on their profitability-as measured by the Return on Rate Base (RORB) was at 12 percent, their actual RORB was never allowed to reach this ceiling. From 1993-1996, Petron's RORB ranged from 3.8-8.8 percent and averaged at around 6 percent annually. This is only half of the allowable return. Returns on risk-free treasury bills, by comparison, ranged from 8.55-16.48 percent during the same period. It has to be conceded, however, that under the regulated system, the oil companies were permitted by the government through the Energy Regulatory Board (ERB), to recover only the cost of crude oil but also increases in operating expenses. From the end of 1992 to early 1996, oil companies were granted several adjustments that improved or at least maintained their RORB. After deregulation, the profit picture for the oil companies worsened. Following the issues that plagued the first deregulation law in 1997, all three major players suffered significant losses. Petron's RORB for instance, dropped to negative 9.1 percent. Although this improved to a positive 3.1 percent in 1998, a figure still significantly lower than the company's RORB in the years prior to deregulation. From this, it is clear that price developments in the fledging deregulated market have generally tended to reduce the profitability of the oil companies. If taken from the point of view of the oil company a reasonable level of price is the one that allows an adequate return on investments. This must over the cost of capital and be above the return on risk-free investments such as Treasury Bills. In short, as of the moment, the oil industry is as of yet a very unprofitable venture to be in. The only way to earn profits is to sell huge volumes of gasoline-related products to compensate for the low price. However, since the demand of the Philippines isn't as great, the oil companies cannot expect a huge sales volume when compared to other countries. Therefore, the most logical step is to increase the price in the hope of increasing the RORB levels to more than that of the Treasury Bills. However, in the advent of the deregulation law, the oil industry could become more profitable in the future. Deregulation was meant to attract new oil companies and make the market conditions more competitive. Domestic oil prices were expected to behave as much as they do in a free market: they will tend to be driven down by competition and make it impossible for any oil company to make excessive profits. Competition will be priced reflect the cost of brining in new supplies, which means the cost of oil products in the global market plus other expenses such as freight, insurance and some margin. Of course, this margin will come under pressure from the competitiveness of the players. Full deregulation has been allowed to work for more than a year now and so far, there are more than 50 new players in the industry and a price of P1.20 lower than it was during regulation (compared to world prices). Many of these are in bulk or wholesale trading, where single-customer volumes are significant. However, there are also new players in the retail trade and they have been aggressive in their investments despite policy uncertainty in the industry. According to the Department of Energy, these new players had a combined market share of 8 percent as of the first quarter. In Thailand, where deregulation was implemented in 1991, it took four years for the share of the minor players to increase by the same portion. By this standard, it appears that oil deregulation is indeed working for the Philippines. Using present trends, the market share of the new players should be close to 25 percent by the end of 2002. The present deregulation law was drawn up after long debates in Congress and after many public hearings. It included changes to the earlier law to correct the defects perceived in the law. There are now incentives available to new players that are not available to the old ones, making it very easy for big global players such as TOTAL, Coastal and Mobil to capture business that the existing players took many years to build up. But domestic refiners do not enjoy any form of protection from same product importers. Nonetheless, there are protective laws and sanctions against unfair practices that are provided in the new law. As far as encouraging new entrants into the industry, R.A. 8479 seems to have all the necessary provisions. However, it should be given enough time to work (provide customers with the best service at the best price), and to serve as the basis for a stable policy that would minimize the risk of those who want to invest in the industry. One drawback of the new law is that it does not encourage investments in local refining capacities. New players and oil traders can always import cheap products from other refineries in the region, thus making it less profitable to invest in a new refinery or upgrades. Since the imported source of oil is subject to some sort of protection scheme, most notable of course, tariff, if the government is truly interested in ensuring long-term reliability of energy supplies and promoting growth of the industry, then such protection may be worth studying. The restoration of price controls on oil products may pose more problems than it is meant to address. If the control mechanism is intended to keep the oil companies from passing on their costs, such that they are unable to maintain a reasonable rate of return on their investments, then this will discourage new investments from both old and new players. It could even force some players out of the market. The assurance of adequate returns is especially crucial at a time when the new Clean Air Act is being introduced and substantial new investments are necessary. These investments can only be made if there is policy stability. If, on the other hand, the price control mechanism tries to assure the oil companies of cost recovery while shielding the public from price increases, the government will have to set up a buffer fund like the OPSF. Based on past experience, this arrangement tends to lead to government subsidy of domestic oil prices. The restoration of buffer funds such as the OPSF would only weaken the already weak public sector. The real question, therefore is whether the government would like to take the risk of not. Currently, the government is deliberating in putting up the National Oil Exchange, which would regulate the prices of distribution, hauling, trucking and storage by acquiring terminals and storage depots for refined petroleum products all over the country. The government will carry the inventory cost of petroleum products bought by the National Oil Exchange. However, this government plan has two pitfalls. The first is more obvious: the government will become a virtual monopoly allowing it to fix the prices of oil in the country. The second is that the government has this reputation is mismanaging its businesses. In fact, though the National Oil Exchange is a non-profit organization, the track record for the government for running such businesses leaves much to be desired, not to mention inefficiency and corruption that could result. An alternative to oil regulation, proposed by Raul T. Conception is to create an independent oversight committee. When approved, this new independent committee will have the power to demand from oil companies records of purchase of crude and refined petroleum products, the rates the oil firms used and the total cost for importation. This transparency and fair dealing will, according to Conception, hopefully convince the consumers that local oil prices indeed reflect those of the world price index, and that no profiteering is taking place. At the same time, Conception says that the government must encourage competition by making them pool their resources for a common nationwide storage and ocean-docking facility to compete with the big three oil companies. The Current Situation The Philippine Daily Inquirer released a report confirming the rather poor profitability of oil firms in the Philippines. Dated December 13, 1999, almost a year into the deregulation, the big three oil firms plus TOTAL posted losses over the fiscal year. Pilipinas Shell posted a loss of 225 million pesos. The reason for this huge loss was that the big three are still forced to sell oil at cheaper than world price levels because of the fierce competition in the market plus public sentiment against the rising of fuel prices. Shell statements said that crude oil prices are currently in the $24 per barrel, while their pump prices only reflect a price of $20 per barrel. On the same note, Caltex Philippines also blamed the same factors and posted a net loss of P200 million. Although Caltex Philippines, with a 21 percent market share wanted to raise prices by 40 centavos per liter in end of November to compensate their losses for the year decided not to burden the public anymore. Similarly, even the smaller market players such as TOTAL are also having difficulty adjusting their prices. In fact, after posting a healthy gain of P74 million in 1997 and P71 million in 1998, the company expects to have loses up to a figure of P20 million, since it could not raise it prices to meet the world crude price level. Currently, TOTAL Philippine's parent company will be holding their budget on the Philippine division until the government can assure that the oil deregulation laws would remain in place. However, president of TOTAL Philippines, Jean Jacques Jung says that his company needs an additional 50 percent increase in budget so that their programs could get back on track. TOTAL Philippines is quite shocked at the Philippine government for planning to put up a sort of 'semi-regulation' to prevent more fuel hikes scheduled for this year. Each oil firms wants an additional 70 centavos to P1 increase in pump prices to meet the world crude oil price. TOTAL's seven-year plan to turn their investments into profits in seven years is now in jeopardy because of the government's 'flip-flop' policies. While profits went down, sales volume also went down during the same period. The combined sales volume of Shell, Caltex and Petron went from 129.523 million barrels in 1998 to 118.950 million barrels in 1999. The big three are pinning the blame on the low sales volume on the slowdown in the Philippine economy. Petron's refining capacity from the maximum capacity of 180,000 barrels a day was reduced to 155,000 barrels a day mainly because of lower demand from Philippine Airlines and Napocor, both of which are big customers of Petron. On the other hand, Shell now only refines 125,000 barrels while Caltex claims that it keeps steady at around 70,000-80,000 barrels daily. While the sales from the big three were slowing down, the smaller companies posted a sales volume increase of 160 percent, from 11.196 million barrels from 5.925 million barrels in 1998.Because of the huge effects of the oil industry to all other industries such as transportation and manufacturing, new price hikes in those respective industries. For instance, electricity prices have increased dramatically by 20.8 percent, while rice, sugar and meat have gone up by five percent. Transportation, on the other hand, has increased by 50 centavos for the first four kilometers. With all of this in mind, the consumers are beginning to feel the pinch of the oil price increase, but do consumers have a choice? Unfortunately no. This is because petroleum is currently an energy source that is very hard to find a substitute for. Gasoline provides the most power for its weight; therefore currently it is the most efficient kind of fuel available. Although the government is currently trying to find new sources of energy such as wind or solar energy, currently every economist agrees that all the countries in the world, the Philippines included, will increase petroleum demand in the next couple of years. This is despite the fact that other sources of fuel are currently available. Petroleum is the most readily available source of fuel and the easiest to convert to usable purposes. This is where the greatest strength of the oil industry lies. Because oil is now considered an important commodity and replacement is hard to come by, people would have little choice but to accept the prices, which the oil firms dictate. Sources Books Villegas, Bernardo M., Strategies for Crisis: The Story of the Philippine National Oil Company, Manila: Center for Research and Communications, 1983. Periodicals "Crude Realities in the Downstream Oil Industry" IBON Facts and Figures, 15-30 November 1997. "RP Behind in Oil Drilling" Business Daily, 09 December 1997. "Tatad Warns of Possible Oil Shock" Philippine Star, 24, February 23, 2000. Batino, Clarissa S., "Oil Firms Say They're Losing P1.7B a Month" Philippine Daily Inquirer, September 17, 1999. Chanco, Bob, "Oil Prices: The Good News" Philippine Star, 24, February 21, 2000. Concepcion, Raul T., "Consumer and Oil Price Watch: Private Sector" Philippine Daily Inquirer, 5, February 16, 2000. Dones, Liberty, "Big 3 Seeking New P1 Oil Price Hike" Philippine Star, 1, February 23, 2000. Estayo, Maximilian B., "Focus: Petroleum Industry Deregulation" Business Daily, 31 January 1997. Gaylican, Christine A., "Petroleum Sales Down 8.8%" Philippine Daily Inquirer, B3, Feburary 22, 2000. Yap, Cecile E., "10 New Petroleum Industry Firms" Manila Chronicle, 5 January 1998. Internet Sites Caltex Corporation (http://www.caltex.com) Hoover's Industry Watch (http://www.industrywatch.com) Inquirer Interactive (http://www.inquirer.net) Motioncars Magazine (http:motioncars.com) National Statistics Office (http://www.census.gov.ph) OPEC (http://www.opec.org) Petron Corporation (http://www.petron.com) Philippine Department of Energy (http://www.doe.gov.ph) Royal Dutch / Shell Group of Companies (http://www.shell.com) US Department of Energy: Petroleum / Oil Data Sheet (http://www.eia.doe.gov) 23 1