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Quo vadis, Petrojam?

William “Bill” Saunders

Sunday, August 12, 2018

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Acquisition of the Esso Kingston refinery in 1982 by the Petroleum Corporation of Jamaica (PCJ) was approved by the Government on the conditions that:

(1) the refinery was always to be the least cost option for petroleum supplies to Jamaica, and to maintain this least cost conditionality it was recognised that the refinery had to be upgraded;

(2) the refinery was never to be a drain on the economy;

(3) the refinery was to be divested at the earliest opportunity, as mandated by the PCJ board.

Structure and form

When the refinery was first built certain incentives were given to Esso, including a Jamaican product price formula, as outlined in a heads of agreement between Esso and the Government. This was initially based on the average of Caribbean prices and later amended to include a “small refinery differential” that provided, for a time, an acceptable return on investment for Esso.

When Esso no longer found it profitable, and were refused additional pricing concessions, the refinery was acquired by PCJ and Petrojam was established. The terms that had been agreed with Esso remained in place and were transferred to Petrojam.

To achieve the least cost conditionality PCJ developed amendments to the Esso/GOJ pricing formula which were accepted by Government. These adjustments generated a cost for each product as if it had been imported in an arm's length transaction between unrelated parties.

The ex-refinery pricing formula comprised:

• the applicable region's product price (initially Caribbean, now Gulf);

• adjustments for quality differences;

• adjustments for freight and ocean loss from source to Kingston; and

• adjustments for terminaling

This formula reflects the costs that any marketing company would face and would, by design, represent the least cost option.

Refinery billing prices were set by converting ex-refinery prices to Jamaican dollars at the applicable exchange rate, then adding relevant taxes and other cost components.

Ex-refinery prices were prepared by Petrojam, audited by the Economics and Planning Division at PCJ, then checked again by the Energy Division of the ministry prior to approval. On at least one occasion PCJ recommended a change to reduce these prices that was approved by the ministry and then implemented.

To ensure transparency it used to be Petrojam's practice to publish ex-refinery prices and the taxes applicable in deriving the refinery billing price. For some inexplicable reason, ex-refinery prices and taxes are no longer published, leaving only a refinery billing price that cannot be easily verified. This makes it difficult for an independent party to confirm that ex-refinery prices remain the least cost option for Jamaica.

If Petrojam's prices are higher than least cost, marketing companies can import and sell at that inflated market price, reaping significant profits and disadvantaging consumers.

Pumping profit

The PCJ was established as a statutory corporation, which means that it was created by an Act of Parliament, unlike companies that are established under the Companies Act. There were no dividends to be paid and all profits were to be used for the development of the sector. At the time of its creation, visionaries like the then minister responsible for energy, Horace Clark, and his permanent secretary, Erwin Angus, wanted to ensure that this fledgling State corporation would never be a drain on the economy. As such, PCJ was to be operated as if it were a private sector company, with the minister's authority for board appointments limited to the appointment of the chairman and board members of PCJ only. The chairman and board members of each wholly owned subsidiary were appointed not by the minister, but by the PCJ board in consultation with the minister.

From its inception PCJ was extremely profitable, deriving this financial independence from offshore refining of crude oil supplies negotiated from Nigeria and Mexico through contracts with Shell Curacao.

The vision was that financial independence for PCJ was to be derived from activities such as these, as well as the development of profitable subsidiaries, primarily in the energy sector, either alone or in association with the private sector.

PCJ's profits were to be reinvested in the energy sector, including in the exploration and development of indigenous energy resources. PCJ reinvested funds in several successful projects, including three hydroelectric stations; purchase of the Esso refinery and upgrades to the refinery; establishment of Petcom for retailing petroleum products; Petrojam Ethanol Ltd in partnership with Coimex of Brazil; Petronol, formerly Bernard Lodge, as well as many other successful subsidiaries. All this without requiring a single cent from the consolidated fund.

The PCJ Group contributed substantially to the foreign exchange of the country, as well as to the consolidated fund in the form of taxes. It is also of importance to note that all funds used from the Capital Development Fund to finance failed projects, such as the precursors to PCJ, including the proposed refinery at Font Hill and the National Oil Company, were fully reimbursed.

The first upgrade to the refinery facilitated local processing of Mexican crude oil, which allowed PCJ to exit its offshore processing arrangement and to refine, at Petrojam, crude oil from a larger pool of suppliers. PCJ continued to refine Nigerian crude in Curacao, as the Petrojam refinery was not designed to maximise the benefits of this premium crude.

From the time of the Esso acquisition Petrojam was profitable, and reportedly still is, although there is no assurance from independent investigators that the refinery still operates as the least cost option. Furthermore, the loss of spiked Venezuelan crude, age, and the lack of certain vital equipment as exists in larger refineries, mean that Petrojam is unable to meet all the product demand of the country, and therefore must import almost as much gasoline, kerosene, diesel, and liquefied petroleum gas as it produces. For many years it has been operating at levels significantly less than capacity.

Tinkering with the model

After its first six years of operations, the group's equity grew from zero to almost $4 billion in today's currency. Indeed, an attractive feeding trough for those who could gain access only if the structure of the corporation were changed.

In the 1990s the corporate structure of PCJ was changed to allow:

• the appointment of an executive chairman;

• Cabinet to appoint boards of subsidiaries without approval of the PCJ board; and

• the Government to become a shareholder, legalising access to PCJ's profits.

Prior to this change, PCJ 's chairman was the group chairman, and the managing director was the group managing director. In this manner, PCJ had control of its subsidiaries who were all accountable to PCJ. When the change was made to allow Cabinet to appoint all board members the accountability chain was broken, with subsidiaries no longer reporting to the PCJ board, but instead to the minister.

In Jamaica, the unfortunate reality is that government boards often comprise political supporters selected because of their party support rather than their technical and administrative competence.

In the succeeding years there were dismissals and resignations of senior staff as the corporation's vision had been changed. Many of these positions were filled with political appointees having little or no experience in the energy sector.

Petronol was closed and key sugar lands diverted to housing, development of Font Hill farms was abandoned, and energy investment projects were ignored in favour of increasing the crude supply from Nigeria that was sold directly to Trafigura, with no processing contract and for a minuscule margin.

PetCom, that previously operated profitably, went into a loss position to the extent that it could not pay Petrojam for product supplies. This was in direct contravention of the heads of agreement that mandated the refinery not to give special preference to any marketing company.

The heads of agreement also stipulated that if the refinery could not meet a required product specification, then the marketing company would be free to import that product.

Again, in blatant disregard of the terms, Shell was penalised for importing a product that the refinery was unable to produce. This is the real scandal of the now infamous “Shell Waiver”, and also illustrates further why the Government should never become involved in operating businesses.

There are now insufficient funds left to carry out the upgrades to the Petrojam refinery that were known to be necessary at the time of its acquisition. These upgrades should have been implemented 20 years ago, as planned, and the delay has rendered any upgrade infeasible at this time.

Way forward

Recognising the age of the refinery, the substantial number of technical improvements in the refining process over the years, and advancements in electric and electronic controls, upgrading is really a euphemism for the rebuilding that would be required. A rebuild cannot be justified as the size of the market available to Petrojam means that it would not survive unless it sold at inflated prices. A rebuild would ensure that Petrojam is not the least cost option.

Indeed, Petrojam faces a crisis for which there are only three possible responses:

(1) Continue 'business as usual', but ensuring that ex-refinery prices represent the least cost option for petroleum supplies to Jamaica. Is this possible without sustaining massive financial losses?

(2) Shut down the refinery and operate as a terminal for product imports.

(3) Innovate and adapt to meet the shifting demand trends such as possible conversion to a biofuel refinery.

In any of these options the refinery should be privatised, thus removing the trough from political interference. Privatisation of National Commercial Bank and Carib Cement transformed them to extremely profitable ventures. Quo vadis, Petrojam?

William “Bill” Saunders served as group managing director of the Petroleum Corporation of Jamaica between 1979 and 1989, and was the first managing director of Petrojam. Send comments to the Observer or wvsaunders@hotmail.com.

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