Subsidizing fuel prices

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Ordinary people in many parts of the world are starting to feel the impact of the US-Israel war with Iran.

According to The New York Times, “the oil shock from the war in Iran has rippled through much of Southeast Asia, upending lives, straining local economies and increasing public discontent. While many countries are contending with the fallout, experts say this region of more than 600 million has been one of the hardest hit.”

The Economist reports that: “Rationing is already happening. The Nepalese are queuing for cooking gas.Sri Lankan firms have been urged to shut on Wednesdays to conserve fuel. Pakistan has ordered schools to shut for two weeks to spare electricity. Chinese refiners are being told to halt exports. This week, South Korea’s government discussed emergency measures including imposing limits on petrol sales to motorists.”

We are also starting to feel the bite of the rapid increases in the pump prices for diesel and gasoline. But because we don’t have a reliable mass transport system, people have no choice but to take the added costs for as long as they can.

We are also the most impacted in ASEAN because market deregulation means our pump prices immediately reflect world market prices. Our neighboring countries have some sort of fuel subsidy given by their government. The peso devaluation provided a double whammy effect.

Some of our politicians are grandstanding by proposing the knee-jerk response of repealing the Oil Deregulation Law. This seems to be a ritual for our politicians.

The Philippine Institute of Development Studies recalls that temptation to reverse the deregulation policy was tested in: 2008, when speculative bubble was building up; 2011, when supply shortages occurred due to the Arab Spring movements; 2017 to 2018, due to the high demand growth (prior to the oil crash); October 2021, due to the sudden jump in global demand when COVID-19-induced mobility restrictions were relaxed and recently due to the Russia-Ukraine war.

But repealing deregulation will not give consumers relief unless our cash-strapped government offers something beyond token assistance to cushion the impact of rising oil product prices.

We had such a system in the olden days under the first Marcos regime. It was called the Oil Price Stabilization Fund (OPSF), established by Presidential Decree 1956 in 1984. It acted as a financial buffer to shield retail consumers from volatile global oil prices and currency fluctuations.

OPSF provided a mechanism that reimbursed oil companies for the additional costs of importing petroleum when world market prices for crude oil rose or the Philippine peso weakened. This allowed retail pump prices to remain steady even when import costs increased.

Conversely, when international oil prices fell or the exchange rate improved, oil companies were required to pay the cost reductions into the OPSF rather than lowering retail prices immediately.

Petroleum prices were reset every two months to reflect prevailing costs, using the fund to “smoothen” these adjustments and minimize frequent changes for the public.

The OPSF was eventually abolished because it became a massive financial drain on the Philippine government. By the mid-1990s, the fund had accumulated a deficit of approximately P17.6 billion, forcing the national government to provide heavy subsidies to cover the shortfall.

The concept of having the OPSF was good in theory. Indeed, Thailand adopted something like it and made it work better for them. As always, our politicians flubbed the implementation.

Our government often delayed planned price increases in fear of a public backlash. This created a mismatch where OPSF paid out reimbursements to oil companies that far exceeded contributions to the fund.

Price adjustments also required mandatory public hearings, causing “lags” that prevented oil companies from recovering costs in real-time. A timely pump price increase would have avoided the problem.

The system relied on cross-product subsidization, where higher prices for gasoline were used to keep diesel and kerosene cheaper. It was presumed that the well off used gasoline more. This encouraged inefficient over-consumption of diesel as the rich started buying diesel SUVs.

It also caused rampant smuggling of our low-cost diesel to our neighboring countries where diesel reflected higher world prices. We effectively subsidized foreign users.

The PIDS notes that while deregulation leads to more frequent price hikes at the pump, it protects the national budget from the “fiscal harm” of massive debt-funded subsidies.

The OPSF could not absorb the shock of a sharp surge in international oil prices during the 1990 Gulf Crisis when Iraq invaded Kuwait. This forced the government to pass Republic Act 6592 to inject P5 billion in taxpayer money just to keep the fund afloat.

The OPSF also had to reimburse oil companies for import cost increases caused by a devaluation of the peso against the dollar. Even when oil prices were stable, a weaker peso drained the fund.

Then our officials abused the Fund. In 1992, legislators allowed the OPSF to be used for non-stabilization purposes, such as paying for capital stock subscriptions for the National Power Corp.

Some of our ASEAN neighbors are subsidizing pump prices of gasoline, diesel and LPG. But these are oil producing countries that have earmarked some of what they earn from their oil reserves to benefit their consumers.

We could have done the same with the close to $15 billion earned in Malampaya royalties but our presidents chose to squander most of it in pork barrel projects. Now, we have nothing to show for it.

Thailand uses a dedicated Oil Fuel Fund to cushion consumers from price spikes. It operates like our OPSF, but is more transparent about its limits. They avoid long-term market distortions, preventing the kind of “infinite deficit” that killed the OPSF.

There is much to learn from our past if only our government has institutional memory. For our legislators who want to repeal the Oil Deregulation Law, siguro, aral aral muna.

Boo Chanco’s email address is [email protected]. Follow him on X @boochanco