The existing method
Sapia's policy of greater openness and transparency implies an on-going effort to increase understanding of key aspects of the oil industry. Sapia believes it is important that everyone should have an understanding of the factors which drive the profitability of the industry.
In terms of the current dispensation two distinct areas have to be considered - refining (deregulated since 1991) and marketing where prices of finished products continue to be regulated. In respect of marketing, as noted on page earlier, Sapia has indicated a willingness to work with Government and other role players on developing new rules appropriate to the new South Africa.
A refinery separates crude oil into its component parts. For every 100 tons of crude fed in, about 93 tons of refined product comes out, the rest is consumed in the process, mainly as fuel.
Obviously, for income to be earned, the refining process must add value over and above the cost of the processes and the cost of the initial 100-ton input.
Two categories of product are created:
The percentage of higher or lower value products produced by the refinery depends on three principal factors.
Higher value products may be resold for higher prices. Crudes which intrinsically contain more higher value product tend to be more expensive.
A similar balancing of the scales is apparent when examining the profit-earning capabilities of refining equipment.
The more extensive and sophisticated the equipment, the greater the anticipated yield of higher value product. This is not only good for the company, but good for the country as optimum output of high value products saves foreign exchange on crude oil imports. However, the more modern and sophisticated the equipment, the greater the capital investment.
The key point of difference in the relative profitability of refineries therefore tends to be the efficiency of operations, or how management and labour maximise the yield of high value product for a given type of crude with the available equipment.
A major factor beyond the control of the refining team is the prevailing margins between the cost of crude oil and refined products in international markets. Oil is an internationally traded commodity. These margins therefore fluctuate in line with global trends in supply and demand and the perceptions and sentiments of a global marketplace. World prices are outside the control of the authorities or other interested parties in South Africa.
The world price of a refined product landed in South Africa at any given time is referred to as the In Bond Landed Cost (IBLC). This is the price at which this product would be available had South Africa sourced the commodity on the global market and freighted it to a South African sea port.
The IBLC is the handover price from the refiner to the marketer. It is also the basis of the price of purchases by the oil industry from Sasol.
Marketing profitability is still governed by official regulation. Profits are supposed to fall within parameters strictly defined by the Marketing of Petroleum Activities Return formula (or MPAR formula).
This formula harks back to the 1970s when the government of the day was in the habit of applying price control to various industries. Key elements of the formula are income before tax and interest as a percentage of total assets. When depreciation is calculated, an adjustment is made to recognise the effects of inflation.
The formula is applied one-year behind current reality (ie those seeking to motivate a 1996 margin increase would quote 1995 figures).
Under the MPAR formula, an aggregate oil industry marketing profit acceptable to government is between 10% and 20%. Should returns fluctuate within the 10-20% band, then no increase is due. Should returns go above 20%, then a margin cut is indicated. Should the return fall through the 10% 'floor', then a margin increase is indicated.
When an adjustment is made, the new cents per litre marketing margin is modified to a level which would have delivered a 15% return for the year under review.
The easiest way to explain the formula is to give an actual example, and the most relevant one is the arithmetic behind the April 1996 industry application for a 3c/l margin increase.
Key elements in the equation for 1995 are shown in the table below:
|
A - Aggregate income in 1995: |
R715m |
|
B - Total assets in 1995: |
R8186m |
| C - Return (A/B x
100): C - (Below 10%, so an adjustment is due under the formula) |
8.73% |
|
D - Amount needed to give 15% (B x 0.15): |
R1228m |
|
E - Shortfall in actual income (D-A): |
R513m |
|
F - Volume in 1995: |
17bn litres |
|
G - Adjustment in cents/litre (E/F): |
3c/l. |
The system is relatively simple. It acts as an encouragement to competition as the margin is based on the total income and assets of all companies. An individual company can improve its relative profitability by reducing its own costs and assets. Each time this is done, it has the effect of reducing the industry total assets and costs. Competition causes the process to be repeated - leading to ongoing cost reductions and increased efficiency for the whole of the South African oil industry. Sapia believes, however, that in principle free competition is far more desirable.
The MPAR system has its roots in the past and there is now a need to develop a new system, acceptable to all role-players, to be applied whilst margins remain controlled.
In its natural state crude oil is of little use. It consists of a mixture of liquid and gaseous hydrocarbons. Before crude oil can be put to its many uses, the hydrocarbons have to be separated. This separation is done by means of distillation, a process founded on the principle that different liquids boil and turn into vapour at different temperatures. When the crude oil is heated, the components with the lowest boiling points (usually the light gases) are vapourised first, and those with high boiling points (destined to become fuel oils) are vapourised last. At an oil refinery this is done in a distillation column. Through this distillation process the crude oil is separated into the following fractions, from the top of the tower to the bottom: