2005-10-27,+Sasols+fantastic+import-parity+pricing+system,+Crotty

= Sasol's fantastic system of import-parity pricing = Business Report, Johannesburg, October 26, 2005

By Ann Crotty

By now most of you will have heard about import-parity pricing. For those who haven't, it is the process whereby a dominant local producer of an indispensable commodity such as steel sells to the outlet down the road at the same price as it would cost that outlet to buy it and ship it in from some far-flung place.

The steel producer does this despite the fact that its local cost structure is considerably lower than the actual cost of buying and importing the steel. The local steel producer does this because it can.

While import-parity pricing is a hugely profitable strategy, it does appear that there is an even more profitable variation. So far, it has not been given a name, but it might be appropriate to describe it as the premium import-parity pricing (PIPP) strategy. PIPP is import-parity pricing on steroids.

The garden variety of import-parity pricing assumes that the product will be purchased and imported in reasonably efficient markets. It assumes you buy the steel on the international market and ship it at reasonable cost to your shop in Vereeniging, next door to the Mittal Steel plant. By contrast, PIPP dispenses with any assumptions about efficient pricing anywhere along the chain from purchase to delivery.

To date there is only one known example of PIPP in practice - the oil industry and, in particular, Sasol. Key requirements of a successful PIPP strategy are that it involve an indispensable product and a market where consumers are price takers, and the active support of the government.

Those whose brains have not been altered by prolonged exposure to oil fumes should be warned that it might be difficult to make sense of much of the following. But here goes.

In South Africa the pump price of petrol is made up of 10 components. The largest is the basic fuel price. Within this price there are seven components, including an international spot price.

The spot price is not for the crude oil that is actually imported to this country, mainly from the Middle East. It is for refined oil in Singapore and the Mediterranean.

Having pretended to buy refined oil from Singapore and the Mediterranean, the industry pretends to ship it to South Africa. This make-believe shipping involves six very real additional costs: freight cost, insurance costs, ocean loss allowance, wharfage, coastal storage and stock financing cost.

For some reason a 15 percent premium is added to the freight cost of shipping the stuff from Singapore or the Mediterranean to local ports.

It is important to stress at this stage that none of these costs are actually incurred by anyone who is in any way involved in selling you petrol at your local service station. It's a very sophisticated makey-uppy thing.

It would be a bit like me expecting the Independent Newspaper Group to pay me what it would cost to get Shakespeare to write all my articles in iambic pentameter. The fact that Shakespeare is no longer alive would not be considered an impediment in the bizarre world of PIPP.

For me, what is an impediment is that I do not have the support of the government; Independent Newspapers is not a price taker; and what I do is entirely dispensable.

Once the make-believe fuel has arrived in South Africa, things become a little less unrealistic. The domestic elements include transport costs, delivery costs, wholesale margin, retail margin, the equalisation fund levy, fuel tax, the customs and excise levy, the Road Accident Fund and the slate levy.

There is little sign of competitive pressure playing a role in determining any of the costs. Instead there is considerable input from the government, obviously in consultation with the major players in the industry.

While all the major oil companies benefit from this peculiar system, Sasol is the largest beneficiary - by a long shot. At some stage the other oil companies actually buy oil at the high prices prevailing in the global market.

However, Sasol, due to its world-class technical expertise and ongoing investment, is able to make it from coal much more cheaply. There is speculation that its costs are about $18 (R119) a barrel, compared with oil at $60 a barrel.

Sasol certainly deserves a reward for its technology, even if it was originally funded by taxpayers. It also deserves something for saving the country from having to spend an even larger amount of dollars than it does on oil imports. But the huge profit it is making on the PIPP system that we are forced to accept is a rather excessive reward.

With the government committed to reducing its involvement in the industry, there is some chance that petrol consumers will see benefits from some competition as this strange PIPP edifice collapses.

Unless, as the competition tribunal has been warned several times during the current hearing, Sasol manages to keep something like it in place through its proposed merger with Engen.

From: http://www.busrep.co.za/index.php?fArticleId=2966223&fSectionId=560&fSetId=662