Islands scramble to cushion skyrocketing world fuel prices

Samisoni Pareti
Between the options of travelling around in canoes and enjoying electricity powered by waves, the spiralling hike in oil prices is forcing islands of the Pacific back to the drawing board. For these islands economies, a number of them small and dependent on diesel power generators, plans for renewable energy are being re-visited as the effect of oil prices begins to bite real hard.

While solar power, windmills and hydro-electricity may be feasible in the medium to long-term, islands nations are desperately looking for some immediate relief that can cushion the impact of rising oil bill.

Niue, for instance, testifies to this vulnerability. In May and June, its wholesale price of petrol was a little over US$1 per litre. Wholesale price of diesel was no better, being sold at just under US$1 a litre. For the same period, the average wholesale price of petrol in the Pacific hovered around US0.54 cents and diesel at US0.56 cents a litre.

Indeed by its calculations, the Investment and Trade division of the Suva-based Pacific Islands Forum Secretariat estimates that the recent price hikes have meant an additional shift of around US$120 million out of the Pacific islands economies each year.

Simply put, we pay a lot more than we did before and this is of significant concern not only to major consumers but governments alike.

It is estimated the total fuel consumption per annum of all 14 Pacific Islands Forum member countries (with the exception of New Zealand and Australia) is just under 2 billion litres. Under the 2000 oil prices, that volume cost the 14 Forum economies US$380 million. Four years later in 2004, that same volume of fuel had cost the region US$608 million-62.5% more.


Too exposed and vulnerable

Admittedly, Niue's case is pretty unusual. Its extremely high oil prices brought about by the high cost of maintaining its temporary oil storage facility (after the previous one was destroyed by Cyclone Heta last year) is expected to take a downward slide, analysts say.

But with the cost of crude oil currently trading at more than doubling the OPEC's preferred price of US$28 a barrel, Pacific islands countries need to urgently devise effective and innovative ways to cushion the impact of spiralling oil prices.

“The FICs (Forum Islands Countries) are considered highly vulnerable as energy accounts for 15-25% of their total imports and over 40% of their gross domestic commodity exports,” Jared Morris, import management advisor with the Forum Secretariat said.

“A Pacific Regional Energy Assessment (PREA) 1992 report showed the tremendous impact of petroleum imports on the economy. The ratio of petroleum imports to total exports is very large for most Pacific Islands countries, between 40-80%, and alarmingly so for some countries where the figures are as high as 500%.”


All avenues exhausted

Morris says petroleum prices have increased significantly in the past 24 months by over 61% from US$43 to US$70 per barrel and there are no signs of prices levelling off.

The Pacific Power Association (PPA), a consortium of power utilities in the region, believes its members have “practically exhausted all avenues to absorb” these oil price increases. Most of them have no choice but to pass these increases on to consumers or seek further government concessions.

“In a majority of our utilities, the cost of fuel alone represents between 60-70% of a utility's budget,” said Tony Neil, PPA's executive director.

“This means that a utility general manager can only focus on reducing costs in the remaining 30-40% of the utility's budget.”

The problem for many of these huge oil consumers is that the fuel hike is also pushing up prices of spare parts and equipment. This would mean that out of the remaining 30-40% of their budgets, a sizeable chunk is being taken up by spare parts and equipment. The costs of spare parts and equipment have also increased because suppliers are passing on the additional costs of production caused by the on-going fuel crisis.

“Those islands that are totally dependent on diesel generation and geographically isolated are likely to suffer the most,” said Neil.

“But it is difficult to state which country will sufer the most, but clearly Tuvalu, Kiribati, Federated States of Micronesia, Northern Marianas, Guam, Tonga, Cook Islands, Palau, Niue and Marshall Islands are those likely to be hardest hit.”


Today's relief, not tomorrow's

For Morris, the view is much clearer than the fog brought upon by the dark fumes of rising oil prices.

While pursuing alternatives to fossil fuel may be the way to go, cushioning the crippling impact of skyrocketing fuel prices ought to be a priority.

Ethanol and coconut fuel may reduce dependency five or ten years from now, but the Forum Secretariat believes people of the Pacific need some relief now.

“Naturally, the bigger the oil price increase and the longer higher prices are sustained, the bigger the macroeconomic impact” said Morris.

“Higher oil prices can lead to inflation, increased input costs, reduced non-oil demand and lower investment in net oil importing countries.

“Fuel price increases typically lead to upward pressure on nominal wage levels.

“These effects are greater with the more sudden and the more pronounced the price increase, and are magnified by the impact of higher prices on consumer and business confidence.”

Already fuel price spikes had added 0.9% to Fiji's annual inflation rate, the country's Reserve Bank reported recently.

So disturbed was the bank's governor of the unsavoury impact of the oil price increase on small islands economies that he wrote to the World Bank and International Monetary Fund seeking timely intervention and relief.

Fiji is reviewing its petroleum pricing template after three straight oil price increases in just four months this year.

The public outcry that ensued prompted the Fiji Government to consider providing some relief to consumers in its 2006 budget to be handed down this month.

As an immediate breather, economists are suggesting three main areas of focus for Forum Islands nations:

• Managing exposure to oil market volatility;
• Improving market competitiveness; and
• Strengthening the regulatory framework.

Indeed discussions of Pacific leaders at their annual summit in Papua New Guinea late last month centred on these three areas.

In a discussion paper, leaders were asked to consider employing risk management tools such as hedging.


Price hedging is a viable option

Hedging is used by utilities in most large developed countries as a way of minimising exposure to price shocks and the volatility of the market. These are financial tools out of reach of our islands utilities and consumers because our individual volumes are too small to entice broker.

Morris said: Our smallness and remoteness work against hedging, which is we are recommending to the leaders a combined hedge for all member countries.

“I have put together a framework where these countries either at the country level or large consumer level can work under one blanket type hedge so that it becomes attractive for a broker.

“You do it as a group because our countries are not going to be significantly different. But for some smaller countries who are almost 100% dependent on diesel for electricity generation, anything they can enter into to protect themselves from rising oil prices is going to benefit them.”

PPA agrees that hedging is one tool islands nations as a group can consider.

By pooling their efforts, the association believes Pacific countries can get the “critical mass” and “cost competitive access” to this financial tool for the benefit of the utilities and ultimately the consumers and manufacturers in the region.

In fact power utilities had been discussing hedging at their conference since 2004 with the Forum Secretariat and Macquarie Bank.

Morris, however, does acknowledge a nagging worry that hedging is mere speculation-gambling about the unknown.

“I believe doing nothing is worse than speculating because nobody knows what's going to happen,” the former Shell Fiji Oil executive told this magazine.

“You've got to decide for yourself or for us as a region what we can sustain before it (soaring oil prices) socially affects us.”

Morris says hedging doesn't cushion the price spikes forever. But it gives consumers and governments the much-needed breathing space.


Energy conservation and efficiency

Exposure to market volatility can also be managed through conservation and efficiency, something acutely absent in the Pacific.

This is being a little bit smarter in the way we use energy, experts say. It may mean walking instead of taking the car to work, or even using non-energy consuming products like bicycles and canoes.

Morris suggests bigger countries like Papua New Guinea, New Caledonia, Fiji and French Polynesia may even consider initiatives like car pooling and road gate tolls. In parallel with this will be the need to introduce or reinvigorate a more robust public transportation system that will persuade car owners to leave their vehicles at home and take the bus or train to work.

“Unless the price is high, people are not going to conserve or being smart in the way they use petrol. It will call for a new set of thinking.”

For providers of electricity in the islands, the oil price crisis is also forcing them to look at energy use efficiency, an area they generally call supply side management.

Said Neil: “Our association has established that major improvements in energy efficiency will result from addressing energy losses in generation, transmission and distribution of electricity in the utilities.

“This will result in more efficient (less) fuel consumption and reduction of operating expenditures for the utility.”

This exercise on energy efficiency has already been verified by the United States Government, which in turn is providing US$180,000 to ensure Northern utilities in the US-affiliated territories continue with their energy efficiency programmes.

PPA is also embarking on a similar exercise in a number of southern utilities to be funded by the European Union. These islands are still waiting for the promised grant from the EU.


Bulk purchasing - the regional approach

A regional approach is also being proposed for improving oil market competitiveness in the islands.

The concept of bulk purchasing is already contained in the Pacific Plan which leaders adopted at their Port Moresby summit in October.

“It's about realising that individual countries or companies on their own may not get economies of scale but together they become more attractive to a potential supplier,” explains Morris.

“Bulk purchasing is about accessing a certain price that you all collectively accessed. At the moment each country (in the Pacific) is doing its own negotiations with oil companies.”

A comparative look at fuel prices testifies to the huge discrepancy of individual purchasing. For the months of May/June this year, Solomon Islands had the cheapest retail price for unleaded petrol at about US0.66 cents a litre.

Pump price in the American state of Hawaii and American Samoa hovered at US0.70 cents per litre during the same period.

Solomons was also retailing diesel fuel in those months at about US0.68 cents a litre. Hawaii and American Samoa had the pump price of US0.70 cents a litre, while Fiji, Papua New Guinea, Samoa and Tuvalu were retailing the fuel at about US0.75 cents per litre.

In his presentation to the PPA conference, Morris spoke about market failure in the procurement and supply of petroleum products due to lack of effective competition in the region.

“Competition is affected by private sector monopoly ownership of terminal facilities, market size, remoteness of location and availability of shipping.

“While many prospective suppliers indicate the market is attractive, this is only when packaged together to warrant the effort of setting up reliable supply chains.

“A balance needs to be achieved between the benefits of economies of scale, the need for perceived competition and security of supply.”


Regional regulatory body needed

In order to effect bulk purchasing of oil in the Pacific region, the Forum Secretariat is calling for the establishment of an “intermediary”-a regional regulatory agency.

Its role is to set up regulations covering petroleum supply, storage, distribution and usage in the region, and then implement and enforce these regulations.

It will have to consider issues like market failure, environmental, health and safety issues for the petroleum industry.

“The appointment of an independent, accountable and well-resourced intermediary is required to broker agreements, manage clusters-procurement, price risk management-and provide regulatory assistance,” Morris said.

He listed five elements that would be indispensable for any joint bulk purchasing agreement. These are:

• Political agreement of management teams;
• Establishment of a secretariat to act as data bank and brokering services to members;
• Signing of a framework agreement (rules of procedure) governing joint bulk purchasing process and procedures;
• Joint bulk purchasing by optimum clubs according to geographical or linguistic grouping; and
• Setting up of a standing committee on tendering.

PPA well positioned for proposed role

Morris believes PPA is “well placed” to assume this intermediary role with seed funding initially to come from stakeholders and donors, and eventually becoming self-sustaining.

To this, Neil said: “The PPA has always played a lead role in the discussions in the framework for joint procurement with the CEOs of Pacific Islands utilities, Forum Secretariat and Macquarie Bank, and is well placed to provide the intermediary type role as proposed by the Forum.

“At the PPA conference, this was an issue that was discussed and supported by our members.

“What we really need to do now is to try and get a framework in place that will allow us to pool together resources to manage our one common issue-the ever increasing and volatile market of petroleum.