Incentivizing smuggling

When the playing field is not even, no amount of efficiency can make a business compete against those who don’t play by the rules, or worse, employ underhanded tactics to gain one over competition.

Take the case of our agricultural sector. The Philippines wants to play by the rules of the World Trade Organization, replacing quantitative import restrictions with tariffs. But there are more developed nations that still do not abide by the rules and are able to get away with it. They continue to subsidize their farmers and sell their cheap produce to countries like the Philippines which have opened up their markets.

This unlevel playing field is also exemplified in the local oil industry.

Why is it that some players are able to sell petroleum products such as gasoline and diesel at prices that are P10 to P15 cheaper? Is it because they are more efficient than others are able to produce products at lower prices?

The answer of course is no. Oil smuggling is a reality in the Philippines. Many local refiners are forced to bring down their prices just to be able to compete with pure smugglers who either sell smuggled petroleum products outright or smugglers who pose as refiners.

I asked a top official of one major oil refining companies in the country why their gasoline and diesel prices are cheaper in some areas. His answer was, these are areas where they are forced to compete with gas stations that sell smuggled products. They are forced to sell at prices that are barely profitable just to survive.

Unfortunately, the Tax Reform for Acceleration and Inclusion (TRAIN) law which imposed additional excise tax on petroleum products incentivized smuggling. Local oil refiners have to pay higher excise taxes after production of fuel products and even before they can be sold. Importers pay taxes on these products only after sale.

Oil refining giant Petron Corp. has cited the increase in fuel excise taxes mandated by the TRAIN law as one of the reasons for the steep 72 percent decline in its earnings this year. As expected, the Department of Finance, through Undersecretary Gil Beltran, defended TRAIN and said that blaming the law for the income drop is unwarranted.

But Nicky Franco, head of research for Abacus Securities, and who has been highly critical of Petron in the past, agreed with Petron and said in his post on social media that one of the consequences of TRAIN is rampant oil smuggling, which allows smaller players to sell products at prices that are 10 percent (or around P4 to P5 per liter) cheaper than Petron’s.

In an uneven playing field, even efficient players like Petron have no way of competing against other players who are able to exploit the system (corruption at the customs bureau).

Inside the Subic Freeport Zone which is a separate customs territory, the playing field is more level.

Enterprises operating inside are exempt from all local and national taxes, and instead are subject to a five percent final tax on gross income. And inside the freeport zone, because smugglers do not have any advantage over legitimate players in terms of taxes and duties, oil companies sell their products at almost the same level.

This is probably the reason why Petron Freeport Corp. (PFC), a subsidiary of Petron Corp. which operates service stations inside Subic Freeport Zone, was able to register double-digit sales and profit growth for the first six months of the year despite the drop in earnings suffered by its parent. PFC currently operates two service stations with convenience stores and leases to several non-fuel locators.

For the first half of 2019, PFC registered a 14 percent increase in sales volume while net income grew 20 percent. Parent Petron’s consolidated sales on the other hand fell seven percent during the first six months of the year while its net income declined by 72 percent.

Outside the free port, various reports would show significantly large retail price disparities of as much as P10 to as high of P15, a clear indication that smuggled oil continues to flow in various parts of the country. This price disparity is much higher than the 2017 level of P7.40 per liter.

PFC’s performance is proof that in an environment where the playing field is leveled, oil companies, or any business for that matter, can thrive.

Putting a stop to smuggling is desirable but unlikely to be achieved by our customs bureau and our law enforcement agencies. The least that our government can do however is disincentivize smuggling by not making locally produced petroleum products too expensive due to taxes.

Those behind the enactment of the TRAIN law may have the best intentions. Unfortunately, the law has unintended consequences and these are things which our finance department and the congressional oversight bodies have to look into and address.

The TRAIN law is killing the proverbial goose that lays the golden eggs. In an effort to raise much needed funds for the public coffers, the law imposed higher excise taxes on petroleum products which legitimate players have no choice but to pay. Unfortunately, the same law serves as an incentive for smuggling petroleum products into the country.

Things can only get worse once Tranche 3 of the TRAIN law is implemented next year, not only for the major oil companies but to consumers as well.

Because of TRAIN, the excise tax on gasoline increased to P9 per liter, and in the case of diesel. to P4.50 per liter beginning Jan. 1, 2019. If one considers P12 value added tax, the total taxes paid that consumers have to shoulder is P13.75 per liter for gasoline and P8.62 per liter for diesel.

These do not include the cost of ethanol or coco methyl ester (CME) which is required to be added to our fuel under the Biofuels Act, which is an additional P3.83 per liter for gasoline, and P1.53 per liter for diesel.

Under TRAIN 3, the excise tax on gasoline will go up to P10 per liter while that on diesel will increase to P6 per liter.

Under TRAIN 2, taxes, including the excise tax and VAT, account for 31 percent of pump prices for gasoline, and 22 percent for diesel. Under TRAIN 3, this will further increase to 33 percent for gasoline and 26 percent for diesel.

But then, smugglers do not have to worry about all these. So while our government provides incentives to smugglers, it is making it more difficult for legitimate oil players to survive, for businesses that rely on cheap transport to make money, for the transportation sector not to ask for higher fares, and for consumers not to hate the government for making life harder for them.

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