DETERMINANTS OF PETROLEUM PRICING IN GHANA
AWUSE NICHOLAS BOLGATANGA POLYTECHNIC SCHOOL OF BUSINESS DEPARTMENT OF ACCOUNTANCY 0243924839/ 0203192445
[email protected]
ABSTRACT Governments spend huge sums of money to import crude oil to meet the increasing demand for petroleum products due to high economic and population, urbanization and industrialization.
Pricing of petroleum products remain controversial in developing
countries, including Ghana. Whereas some experts argue that price regulatory regime protects the interest of the poor against excessive price hikes; others think it deprives the government of much needed revenue for development. This paper presents the extent of relationship between retail petroleum pricing and its key determinants. We shall analyze the socio-economic effects of petroleum deregulation on Ghanaians. The study period spanned from 1985-2005. The results indicated that there was strong relationship between retail petroleum prices and the key determinants and for the deregulation, it was also revealed that the public preferred regulation regime to deregulation. Keywords: Petroleum, Retail Prices, Regulation, Deregulation, National Petroleum Authority, Tema Oil Refinery, Oil Marketing Companies,
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INTRODUCTION
Increasing industrialization, globalization, urbanization, population growth and the need for significant economic growth have in recent times led to high petroleum consumption in many countries including Ghana.
The fact that there is declining reserves and limitations imposed by supply capacity in the world, this has led to increased demand which has translated into high oil prices.
The recent increases in economic growth rate and annual population growth rate, which recorded 5.8%, 5.9%, 3% and 3.1% growth in 2004 and 2005 respectively, (GSS, 2005; ISSER, 2004) have led to additional increases in consumption of petroleum products. The rapid increases1 in international crude oil prices, depreciation of the cedi against United States Dollar and other major currencies implies that the cost of insurance and freight price of petroleum products are very high, Nkoro (2005).
Under the current deregulated petroleum pricing regime, the rise in international prices of crude oil is always passing on to the consumers with its attendant social and economic ramifications, (Hammond, 1994); and African Development Bank Energy Research (1999); Lewis (2003). In an efficient retail petroleum market (or in a perfect competitive market), the price consumers pay should reflect the social cost of producing an extra litre of petrol, thus expump price (p) of petrol must be equal to the marginal cost (mc) of an extra litre supplied, p = MC. (OPEC Magazine, 2005). However, in Ghana’s petroleum products market, this is not the case for three main reasons. The market is not perfect competitive – the imperfection in the market could result in a situation whereby price is less than marginal cost, Mba – Afolabi, (1999). Here, consumers do not actually pay the true economic cost of the petroleum products. The inability of the poor and the vulnerable consumers to pay 1
Ministry of Finance and Economic Planning Annual Budget and Fiscal Statement for the Year
Ending 2006.
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realistic price for the products and to prevent the dislocations of the economy or the high unemployment situation in the country that would be more serious by the increased in petroleum products prices, Nmodu, (2003). In view of the above, government turned to regulate the prices of the petroleum products in order to take away the negative effects of the price changes,(Peltzman, 2001); Pershing and Mackenzie, (2004).
The recent increases and decreases in the prices of petroleum products have led to mixed reactions from both the general public and private sector. The critics have accused the government of insensitivity to the plight of Ghanaians (by heavily taxing petroleum products), (Eckert and West, (2004); Hassain, (2003). Others argued that factors such as high crude oil prices, exchange rate depreciation and others are responsible for high domestic price of petroleum products, (Gupta et al, (2002). Certainly, continual rise of domestic price of petroleum products has adversely affected the economy in the form of increased inflation, increased cost of doing business and consumer welfare effects, (Geweke, (2004). In this paper, we shall analyze the socio-economic effects of petroleum deregulation on Ghanaians.
RELATED WORKS
THEORY OF PETROLEUM PRICING
Prices refers to the amount of money that has to be paid to acquire a given good, service or resource, (Meyer and Taubadel, (2004); Peltzman, (2000); and Wlazlowski, (2003). Operating as a measure of value, prices perform a significant economic function, distributing the scarce supply of goods, services and resources to those who need or want them most through the adjustment of supply and demand, (Shephend, (1990). Prices of resources are called wages, interest and rent, (Cole and Arthur,1938; 1950; Vila; 1998; Duisenberg, (2001).
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FACTORS INFLUENCING INTERNATIONALCRUDE OIL PRICES We divided the factors into demand side and supply side factors. In economic terms, the equilibrium price of oil is determined when quantity of oil supplied and quantity of oil demanded are equal. For any increase in demand, if supplies of oil do not increase by the same proportion, the price of oil will have to be adjusted upward and vice versa. According to the International Energy Agency (IEA), 1999 and US International Energy Department, 2000, demand side factors responsible for the rapid increase in demand for petroleum products include; rapid increase in demand for petroleum products in Asia especially China’s booming economies, and India, demand from other emerging markets, as a result of rapid economic growth, continued increase in consumption from the USA and the European Union as largest consumers. The supply side factors are the slow growth of Non-Organization of Petroleum Exporting Countries (OPEC) supply resulting in increasing level of “OPEC Call”, limited excess capacity among OPEC members and non-OPEC producers especially Russia, political instability and uncertainty in major producing countries in Middle East, Nigeria, Venezuela, lack of any major discovery in the past two decades, Bettendorf, (2003). There is also market induced or “artificial” price increase that is caused by the activities of speculators. Crude oil prices in the world petroleum market in 2004 reached record high. Prices for West Texas Intermediate crude, which is used as an indicator or benchmark for world oil prices in 2006, reached $75 per barrel because of the political unrest in the Middle East. The US Energy Information Administration estimated that a global crude oil demand grew at 2.5% in 2005 and will grow at 3.5% in 2006 respectively, reaching 84.7 and 90.2 million barrels per day, (International Energy Agency 1999; 2003; 2004). The tight
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supply and demand situation in the US petroleum product market; a marked drop in excess supply capacity in the international petroleum market; terrorism, conflicts in the Middle East and political upheaval in Venezuela, oil companies financial and operational difficulties and other problems in major oil producing countries resulted in concerns about supply interruptions; as well as very active speculation in the futures market, (Beers and Moore, (2001), Borestain, (1997). SUPPLY SIDE FACTORS: One of the factors from the supply side that influenced the price rise is lack of spare capacity, (Fesharaki, (1976), Mossavar- Rahmani, (1981). The price crash of the late 1990s discouraged OPEC member countries from investing in capacity expansion. The high growth in demand in the past three to four years has not seen a commensurate increase in investment by OPEC countries, resulting in the world virtually running out of spare capacity, ( Deffeyes, 2005). DEMAND SIDE FACTORS: International Energy Outlook (2006) has revealed that world oil demand will increase by 47% in 2007, ( Katahuria, 2004). Out of that the Organization for Economic Corporation and Development (OECD) Asia, including China and India account for 43% of the projected increase ( Nwachukwa, 2006); (Nan & Murry, (1992). General Factors Affecting Retail Petroleum Products Prices In a free market setting (unregulated market); it is demand and supply that determine prices. This does not always produce the desired outcome; therefore government intervenes. It is the same factors that influence international crude oil prices that are
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transferred into the domestic economy except the level of taxation and margins that differ, (Mork and Knut 1989; Hossain et al, 2000); African Development Bank (1999).
METHODOLOGY This section considers the methodology followed in the study and deals with the data collection methods, research design and data analysis. Basically, there are two methods used in the study, BeBoef and Suzanna, (2001). The field study approach was used to collect primary data to assess the welfare effects of petroleum price deregulation in Ghana and the econometric estimates for determining the key variables responsible for retail petroleum price variation in Ghana, (Bachmeier, and Griffins, (2003), Johansen, (1990). Econometric estimates were performed on secondary data collected from 1985 – 2005 using co-integration and error correction model, Bettendorf, (2003); Cordukes, (1990); Johansen and Julius 1988; 1990; 1996). Primary data was collected through questionnaire and interviews with stakeholders in the oil industry. The primary data was analyzed using simple pie charts, frequency tables while Secondary data was collected from the books of Bank of Ghana, as well as Ministry of Energy and its allied agencies. Primary data was collected to assess the welfare effect of petroleum price deregulation in Ghana. The Secondary data was collected to determine the key determinants of petroleum prices in Ghana.
Research Design First part of the research employed explorative research method in order to get a better understanding of appropriate petroleum pricing in Ghana. The second part is an analytical research method and was used to evaluate the effect of petroleum deregulation in Ghana and examine the relationship between retail petroleum pricing and the key determinants. The population was spelt out in terms of element and sampling unit.
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Data Collection For the primary data, a total of 210 questionnaires were administered to the general public, Oil Marketing Companies (OMCs) and the oil industry while secondary data was collected from Tema Oil Refinery, Bank of Ghana, Ministry of Energy and other oil related companies for deregulation and econometric analyses respectively. The variables to be used in this study are retail petroleum prices, crude oil prices and the exchange rate. The data was collected from multiple sources including Bank of Ghana, Ministry of Energy, Ministry of Finance and Economic Planning, The Budget Statements and Economic Policy of Various years, Energy Commission, questionnaires, interviews and relevant research works as well as Mass media publications were employed. Most of the relevant publications used include the following: Oil and Gas Journal, Crude Oil Platt’s, Crude Market wire, Refined Products, Crude Oil Market Scan, LP Gas : LP Gas Wire. Sampling Technique The technique used in selecting samples for the interviews and questionnaire responses for the top management personnel and the Oil Marketing Companies (OMCs) was purposive sampling. Few Directors and Managers from National Petroleum Authority and Tema Oil Refinery ( NPA, TOR) and other public and private organisations were interviewed. The questionnaire were given to three main groups, namely, top management personnel in the petroleum industry, that is Tema Oil Refinery(TOR), Energy Commission, Ministry of Energy, and National Petroleum Authority (NPA) ten each as one group, Oil Marketing Companies (Total, Goil, Shell, Mobil, Unity, Excel and Nasona ten each as another group. Ten questionnaires each was given to the two groups. The third group consist of public and private organisations (Officials from Education Ministry = 10, Health = 10, Students = 10, Agriculture =10, Spare parts dealers = 10, provisions stores (including five Supermarkets) =10 and Ghana Private Road Transport 7
Union (GPRTU) =10. For the general public, 70 questionnaires were administered, that is 40 for those who can read and 30 for illiterates. The technique used was the stratified sampling, here people with similar education backgrounds and no formal education were grouped and those who could read were given some of the questionnaires to respond and those who could not read and write were interviewed.
Models Specification ASYMMETRICAL RELATIONSHIP MODEL Asymmetrical petroleum pricing in Ghana can be expressed as follows:
RP=f(WP, X,T, R,P) Where: RP
=
retail petroleum prices
WP
=world crude oil price
EX =
exchange rate
T =
taxes paid to government of Ghana
R = refinery cost P = political commitment to be used as dummy.
Since we, assumed that R and T were zero because they were relatively stable over the period under consideration, the model becomes: RP = f (WP, E, P) + ET Since the extent of political interference could not be measured, p was dropped to obtain;
RP = F(wp, Ex) + u
εt = error term Taking the natural logarithm, the linear form of the regression equation becomes; LnRP(t) = βo + β1 LnWP + β2 Ln Ex + εt Where: Ln = natural log; t = time interval; βo = Constant; β1 = coefficient of world crude oil price; 8
β2 = coefficient of exchange rate determination
The above equation is the structural long run model. The log became necessary due to the large size of the data; the use of the log will make outcome more consistent and permit the use of percentages. The Error Correction Mechanism(ECM) developed by Engle and Granger (1987) is a means of reconciling the short run behaviour of an economic variable with its long run behaviour. LN∆RP = βo + Σ β1 LN∆RPt-1 + Σ β2 LN∆WPt-1 + Σ β3LN∆ EXt-1+ β4ECMt-1 + Σt Again, BCG (1997) in US empirical work found gasoline prices can be adequately explained by the crude oil prices. Therefore, we abstract from the effects of T and RP and explained the ex-tax price of petroleum price (PP), with respect to only PC and E, that is, the linear form was given as: PP = F (PC, E) + seasonal dummies…………………………………………3.1 Where,
PP =RP – T
In Granger two step procedures, first OLS is used to estimate a relationship between PP, E and PC. In the second step, using one period lagged value of the residuals (Z) of this OLS equation, the following dynamic error correction model (ECM) can be estimated when price adjustment is unequal: ΔPGt =
k
j
i o
i o
BcidPCt i BeidEt i + ΦZt-I +εt……………..3.2
ΔPGt was used as proxy for retail petroleum prices. And ei is the coefficient for the exchange rate where; ci is the coefficient for crude oil price; gi is the coefficient of retail price rate. Note: B= β and d =Δ, PGt-I = βgiΔPGt-i. The estimate of the parameter θ is the speed of adjustment of prices. However, BCG assumed special lag structure where n=k=j=2. The unequal price adjustment equation can be derived from equation 3 in a straightforward manner and it is:
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ΔPPt
=
n i
n2
n 3
n4
i 0
i i
i 0
i 1
B cidPC t i B gidPG t i o Zt i B cidPCit i B giPGt i O Zt i εt-i……………………………………………………………………3.3 Note: B+ = β+ B- = β-ci
or gi or
ei
O+ =Φ+ and O=-Φ The superscript + stands for coefficients and variables when there is an increase in PC and superscript – coefficients and variables when there is a decrease or change in PC. When PP was regressed on PC and E, to obtain Z for the estimates, we found that the coefficient of E was highly insignificant. It is well-known that the coefficient estimates of this OLS equation are super-consistent, especially when the dependent variable is regressed on only one explanatory variable. n
LNΔRP = β0 +
1 i
n
n
β1LNΔRPt-i +
1 i
β2LNΔCPt-I +
1 i
β3LNΔEXt-I + β4ECMt-I +
εt ………………………………3.4. Where β4 is the speed of adjustment of petroleum prices. The equation is the short run dynamic error correction equation.
DATA PRESENTATION
Introduction The Primary data was collected to seek people’s views and opinions about the effect of petroleum deregulation programme. Though these may be perceptions, they are very important facts on the grounds for policy decision making. The section looks at deregulation in the context of normative economics that is value judgment, on the part of the populace, the responses from the general public may not be based on sound economic analysis, yet important for policy decision making. The other part analyses the regression results and to offer economic, political and social interpretations of the results, thus 10
socio-economic effects of petroleum pricing in Ghana. Survey results were also presented.
Out of 210 questionnaires given out, 183% of them were retrieved representing 87.3%, which can be described as excellent. With the exception of the questionnaires for the NPA, the rest were all administered personally. Various reasons were given by the respondents for their inability to return some of the questionnaires.
FINDINGS 1. Econometric Estimates Below is the long-run equation of the model
lnRP = -0.76075 + 1.2672WP + 0.64380EX. R2 = 0.12162 T-ratios = 0.29306wp, 0.0428ex **= significant at 5% level.
DISCUSSION
The long run test statistics (table 4.2.3) reveal that crude oil price and the exchange rate are the key determinants of the retail petroleum prices in Ghana. The Coefficients of LNWP and LNEX are 1.2672 and 0.64380 respectively, which are positive and statistically significant at 5% level. Again the coefficient of the constant is -0.76075 which is statistically significant at 5%. These suggest that in the long run, an increase of one percent in crude oil price or exchange rate is associated with an increase of less than 126.72% or 64.38% in retail petroleum prices. Alternatively, a unit increase in the crude oil prices will lead to 1.2672-0.76075 (0.50645) unit change in the retail petroleum products prices in Ghana. Again a unit increase in the value of the Ghanaian Cedi against the US Dollar will lead to 0.64380-0.76075 (-0.11695) unit change in the retail petroleum prices in Ghana. The crude oil price coefficient is statistically significant at the T. Ratio 11
of .29036 which implies that crude oil prices are a major determinant of retail petroleum prices in Ghana. This is an indication that though a world crude oil price is a crucial determinant in retail prices in Ghana, the exchange rate also influences retail petroleum pricing. The expected partials have also met the right signs, they are statistically significant and the model can predict perfectly. The relations among the variables showed strong relationships among the explanatory variables on one hand and the dependent variable on the other. The R-square of the regression is given as 0.12162; this shows that about 12% of variability in the dependent variable is explained by the variables. Compared to the Granger two step R- Square of 0.566 lagged and flexible of 0.8055. This is an indication that the Fiji model has high predictive power more than the Ghanaian model and this may be due to the fact that weekly or data in Ghana have not been used, thus affecting our predictive power. Thus about 88% of the variability in the dependent variable like the retail price is unexplained by the model. This implies that factors such as crude oil price and exchange rate account for the variation.
The results
above indicated that crude oil price and exchange rate are not the only key determinants of retail prices in the country. These findings are not consistent with the null hypotheses that crude oil and exchange rate are major determinants in retail petroleum pricing in Ghana.
It was found out that there was significant positive relationship between world crude oil prices and retail price of petroleum products. It was again established that there is a significant relationship between the exchange rate and the retail petroleum prices in Ghana. It was found out that the speed of adjustment parameter in Ghana was much slower i.e. about 18%. Exchange rate depreciation, which influenced so much in retail petroleum prices determination in Ghana, is now giving way to the world market prices of petroleum products as a major determinant due to relative stability of the cedi. The R-Square of 12% is a good predictor since the model is in long run.
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2. Field Survey Frequent petroleum prices increases have the possibility of sparking price wage spiral in Ghana. Theoretically and empirically, there is enough evidence in both Ghana and internationally. Most Ghanaians preferred big increases in retail petroleum prices to small but seldom increases. Most people prefer regulation regime pricing to deregulation regime which they associate with frequent increases in retail petroleum prices. Fig. 4.1.2: Drawbacks of the Former Pricing Regime i.e. Regulated Pricing.
12% problems of regulation no regulation problem 88%
Source: Researcher’s Field Work (2005) Secondly, officials from TOR and NPA representing 12% of the respondents jointly agreed that there are problems associated with regulating petroleum prices and enumerated some of the common problems associated with regulated price regime as: (i) Smuggling to neighbouring countries where prices are high. (ii) Loss of government revenue (iii) Retards economic growth and development because huge sums of money are given to the public as subsidy, which should have gone into development projects but never, reach the poor. For instance TOR’s debt of about ¢ 42 trillion could be used to provide social services to Ghanaians and free government from donor dependence.
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(iv) It increases the gap between the rich and the poor because those who own cars benefits more than the rural folk whose interest it was claimed to serve. (v) It puts pressure on the international reserves, since we withdraw more of our reserves to import more crude oil. (vi) Regulation leads to over consumption of petroleum products. Fig 4.1.6: The Effects of Deregulation on Households 1%
lives affected by petrol price increas es lives not affected by petrol price increas es
99%
Source: Researcher’s Field Work (2005). Asked whether the increases in petroleum prices affected their personal lives, 99% of the respondents answered affirmative and indicated that cost of living has gone up as a result of the increase in the petroleum prices, with only 1% of them answering no. According to the 99% of the respondents: Transport costs have gone up The value of real income has been eroded Inflation has led to wage price spiral Operational cost of industries have gone up (mining, manufacturing, construction) Non- competitive small businesses have folded up Political and social aspect of deregulation has led to disturbances as evidenced by ‘’wahala’’. 14
Government can be made unpopular. Economically, it means that deregulation according to these respondents has led to increases in the prices of goods and services. Thus the increases in fuel prices have the effect of reducing their real incomes or eroding their purchasing power and for that matter impacting negatively on their welfare. Interestingly, there were divergent views regarding whether frequent petroleum price increases has affected their business profit margins positively or negatively. About 80% of the respondents expressed that petroleum price increases affected their profit margins negatively because transport fares have gone up, operational cost of firms have also gone up, real income of workers and traders have reduced hence sales volumes have also gone down considerably, while 20% of them responded that it has not affected their profit levels negatively. Economically, so many firms and business entities costs of production have risen and with their inability to shift this increases to the final consumer, then the profit margins of these businesses fall drastically thus threatening their very survival.
Limitations of this Study
The main findings of the study have been affected by the non-availability of data for petroleum tax, political interference and the refinery cost in the case of short run. This has caused the low R –Square of 12% but in the long run the figure is correct and 64% in Fiji which is the predictive instrument for the study. The model therefore has only 12% predictive power in the short run which means that about 88% of the retail petroleum price variation in Ghana cannot be explained by this model for the period. The 12% RSquare is said to be within the long run estimates and is perfectly acceptable.
The model therefore has very strong goodness of fit in the long run and can be relied upon solely for decision making in Ghana but in the case of short run it cannot be relied upon but needs further modernification. It is therefore recommended that future research should consider adding these three variables to determine the level of causality between retail petroleum price and the key determinants in Ghana. 15
Another possible reason for the low R-Square is the fact that the model only considers the long run effect of petroleum price asymmetry using co integration and Error Correction techniques other than the short run effects of the model.
CONCLUSION Although deregulation will reduce/eliminate government subsidy on petroleum products and make more revenue available to the government to undertake development projects, care must be taken to cushion the poor against excessive increase in the prices of petroleum products in the wake of high and continue international crude oil prices. In conclusion, the existence of National Petroleum Authority to monitor and evaluate the OMCs must be left alone without political interferences to achieve the desired objective
RECOMMENDATIONS
General public (spare parts dealers, transport unions, provision stores, etc.) did not understand the concept of petroleum deregulation. More education therefore is necessary. Retail petroleum pricing formula should be made more transparent and available to people to calculate for themselves any change in the retail price levels. Because Ghana is a small country, she cannot influence petroleum prices in the world market, it can tighten her monetary policies to minimize the inflationary effects of petroleum price increases. Labour Unions should be involved in the fixing of retail petroleum prices to avoid frequent strikes and disputes. Transport system must be improved on in order to cushion the poor against price hikes.
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