Liquid Fuels Wholesalers Associations Briefing to the Parliamentary Portfolio committee 24th July 2013.

AgendaA brief overview of the LFWA and why it was

established. Different types of WholesalersThe developments in the Liquid Fuels Sector ( over the

last 20 or so years ) that created the need for change.The Current situation : Petrol : Diesel : Illuminating

Paraffin (IP)The constraints to Transformation LFWA Recommendations going forward. Questions

Brief Overview of the “ LFWA”

An association not for gain, who’s members shall be limited to entrepreneurs in the Republic of South Africa who are engaged in activities relating to the Wholesaling of Liquid Petroleum.

The LFWA vision is to be an independent recognized body that ensures Liquid Fuels Wholesalers operate in an environment that is intended by all relevant legislation.

Transformation not negotiable Participate fully in all legislation / regulation interactions, support

results. To be fully compliant with competitions Act

Nov’2011 – set up association to address the Sustainability of Independent Wholesalers ( Non Integrated Marketers )

Feb’2012 – first public meeting in PMB. (strong support across most brands )

Aug’2012 – accepted by DoE ( RAS Technical committee ) (representivity accepted)

Identify all licensed & different types of wholesalers

List of wholesale licenses issued ( DoE website)Attempted to trace ( Phone book / websites /

industry knowledge )Large portion not found ( 75% ). Three types of

active licensed wholesalers : Integrated Wholesalers ( Oil Majors : engaged

in refining and wholesaling ) Non Integrated Wholesalers ( Independent

Wholesalers : engaged in wholesaling with infrastructure )

Trading wholesalers ( no infrastructure )

Types of wholesalers & activities

Refining / Manuf

Trading Primary

TransportPrimary Storage

Selling & Marketing

Secondary Transport

Secondary Storage

Retail Customers

Commercial Customers,

Brokers & IW'sIntegrated Wholesaler Integrated Wholesaler Integrated Wholesaler Integrated Wholesaler Integrated Wholesaler

Trading Wholesaler / BrokerTrading Wholesaler / Broker

Independent WholesalerIndependent WholesalerIndependent WholesalerIndependent WholesalerIndependent WholesalerIndependent Wholesaler

ActivitiesTYPES OF WHOLESALER

Changes in the Liquid Fuels Industry

Previously Integrated Wholesalers supplied the market from end to end i.e. from refinery to end user.

Averaging and Cross subsides were accepted as the norm when performing all the activities.

When using averaging in the Wholesale Margin, Zone Differentials and Service Differential (Storage and Handling and Secondary Transport) this methodology creates two different types of customers : those where the actual cost to serve is below the average cost recovered and those where the actual cost to serve is above the average cost recovered.

These different types of customers are largely determined by area i.e. mostly urban vs rural but not exclusively so e.g. small drop customers in urban areas are also typically above the average.

Severe margin pressures and the suspension of MPAR dictated that the Integrated Wholesalers were forced to find a new way of doing business.

Distributors (after licencing now called Independent Wholesalers ) were set up as lower cost operators as a solution to supply the high cost business.

Integrated Wholesalers retained the business where the cost was below the average and passed on to the Independent Wholesalers the business where the cost was above the average. (The understanding of this is critical in addressing the future )

To enable these Independent Wholesalers to perform this function they needed to invest in normal business expenses which includes land and buildings, storage equipment, vehicles, staff and marketing and selling expenses .

Many Independent Wholesalers have therefore been set up to fail. They incur the actual costs of doing business which they cannot offset with the cross subsidies of doing business in areas where the costs are below the average.

A HISTORY OF WHOLESALE AND RETAIL MARGINS 1990 - 2011

As the Integrated Wholesalers have exited these high cost markets they have discontinued submitting these costs. The result is that the averages currently applied are no longer true averages.

Furthermore the current margin mechanisms uses data that is known to the Integrated Wholesalers e.g. the costs of central high volume depots and delivery costs to efficient sites e.g. retailer sites. The margin mechanisms exclude the high costs of servicing smaller commercial customers and remote retail sites.

Operating Costs of Independent Wholesalers are also not included. The Integrated Wholesalers remain in full control of the margins since

they control the product supply and supply chain. The Integrated Wholesalers partially remunerate the Independent

Wholesalers via rebates or discounts. They keep what they require to maintain their shareholder expectations and only give away what they can afford. These discounts have no bearing on the actual costs of the Independent Wholesalers.

Discounts are given at the Integrated Wholesalers discretion and there is no mechanism to ensure that cost elements of the current margin are transferred to where the cost actually takes place e.g. Secondary Transport element to Independent Wholesalers who collect their own product.

Changes in the Liquid Fuels Industry Cont.

RAS – what can we learn ?

MPAR created overtraded environment Deregulation would cause blood bath – new entrants will be the prime candidates for

failure Task 141 – RAS - stepping stone to give industry time to get robust. RAS go live 4th December 2013

Expense Recovery and Return on Investment are the primary focus of the RAS guidelines. The mechanism is Activity Based and requires actual costs to be populated in the

templates to ensure regulatory fairness to both the oil industry participants and the end consumer.

Market related returns and indices are used in calculations eg for the return on investment

Defined mechanisms are in place to keep the RAS margins up to date eg wages and electricity adjustments.

RAS currently only applies to retail petrol.

ISSUES for Independent Wholesalers: Independent Wholesalers are not protected by regulation as the Fuel Retailers are. The Wholesale Margin and Service Differential does not include the all the costs or the

actual costs of servicing the market eg IW’s depots and small delivery customers. Independent Wholesalers will purchase product at a non activity based price and sell to

Retailers at activity based prices – this exposes the problems with the current wholesale margin methodology.

Solutions

Policy discussions on diesel, IP and retail diesel are ongoing but need to be finalised.

A review of the Wholesale Margin, for all products, needs to be concluded to ensure that the activities and costs of all participants are included.

The Service Differential (Secondary Storage and Distribution) need to be reviewed to include all costs and actual costs. In order to avoid cross subsidies it may be necessary to capture and remunerate these elements in the Zone Differentials ?.

Mechanisms must be in place to ensure that wholesale margin stays intact and that the costs and returns accrue to those who have incurred them.

Cross subsidies must be removed or only used as far down the supply chain as possible.

Independent Wholesalers negotiations with the Integrated Wholesalers must be Activity based.

It is not expected that the Wholesale Margin be regulated but that it at least be correct.

To level the playing fields and facilitate new entrants Independent Wholesalers also need equal access to product supply. Severe constraints exist in the area’s of coastal storage, injection points into pipeline and pipeline take out points at the national grid of depots.

An environment must be created where the objectives of the P.P.A can be met.

Transformation – what are the issues ?

This is an unattractive industry because the current cost recovery and pricing models do not :

Promote “ an efficient wholesaling sector” Facilitate an environment conducive to efficient

and commercially justifiable investment in the wholesale sector

Providing for the creation of employment opportunities and the development of small business in the petroleum sector

Ensure countrywide availability of petroleum products at competitive prices.

(Extracts from PPA – 2003)

The Moerane Commission: a reminder

The Moerane Commission: Outstanding :

A holistic review needs to be conducted of tariffs and pricing structures in relation to all modes of transport, with a particular focus on the Durban to Inland market.

It is recommended that a comprehensive review of the petroleum pricing regime be done to address the matters referred to in this Report.

Further to the above we are also of the opinion that the Moerane commission also makes vital recommendations to investigate the Liquid Fuels Industry in the following two areas:

( I ) Service differential : its role in facilitating the development of storage and transportation infra-structure; and

(ii ) Removing Barriers to Entry for New Entrants .

The Risk is very real

40% of some and up to 70% of other Integrated Wholesalers Commercial Business ( Including Co-Ops, GD’s, White pump sites and small retail sites, mostly in the rural areas are supplied by Independent Wholesalers )

Independent Wholesalers collectively supply aprox 6 billion lts of fuel per annum into the SA economy.

Integrated Wholesalers are not in a position to take this business back.

If actual costs are not recognised this will force Independent Wholesalers to do the same as the Integrated Wholesalers have done i.e. exit non profitable customers and areas.

The outlying areas and new entrants will be the first to be effected.

The role of the LFWA.

Facilitate real transformation. Establish actual cost to move a litre of hydrocarbons from refinery gate

to customer ( RAS and IW’s data templates begin to address this ) Support DoE in gathering, managing and implementing solutions. Ensure supply negotiations result in more equitable solutions by training

and promoting the understanding of the margin elements Understand that market forces must be allowed to create the balance. Facilitate the removal of Cross subsidies and ensure that actual activity

based costing be introduced. LFWA to ensure decent return on investment , this to ensure

sustainability and facilitate true transformation. LFWA to have input into New TOR MDZ study ( links between various

cost recovery elements needs creative thinking ) LFWA wishes to participate in the drafting of “ Facilitate development

and access to beginners’ guides into wholesaling clearly setting out critical success factors. “

LFWA to participate in the “ creation of a benchmark Independent Wholesaler -- for realistic HDSA wholesale license conditions.

Create a Conflict Resolution Mechanism with DoE as the Arbitrator.

Thank you

Questions

As a reminder --Diagrammatic representation of the current supply chain

( B ) Primary storage and

transport

( A ) Refinery

gate

BFP Pipeline – rail –road. One or a

combination of these modes of transport used

May be more than one primary depot.

( C ) Secondary storage and transport

Sale to refining wholesaler ( in

limited cases sale to non refining

wholesaler )Sale to Independent

wholesaler who collects and

transports to own storage facilities

Sale to Independent wholesaler who collects and distributes directly to own customers

Customer Storage –owned by

refining wholesaler, independent wholesaler

or self.

Sale and delivery to end customer

Sale and delivery to customer

The above actual cost of servicing the market must be established in a transparent manner.

Why the transformation objectives are not being met

PETROLEUM AND LIQUID FUELS CHARTER FINAL AUDIT REPORT (5th August 2012 )

DOE must ensure the enforcement of the petroleum and liquid fuels charter by all, and in particular: “ Revise the regulatory barriers which disadvantage the HDSA wholesalers”

Address inadvertent unfair competition by oil Majors. Set measurable stretching targets for wholesaling with clear indication of

requirements with respect to all types of wholesalers.

In terms of enterprise development, DOE to:

Facilitate development and access to beginners’ guides into wholesaling clearly setting out critical success factors.

Consider rationalising number of licensed wholesalers. Facilitate creation of a benchmark for realistic HDSA wholesale license conditions. Continue to support HDSA wholesalers in all of its departments and entities by

designing and enforcing policies that favour HDSA’s., e.g. in procurement (end quote)