Saving an oil refinery

Some weeks ago, Petron shut down its oil refinery in Bataan for business reasons. Demand for petroleum products dropped drastically because of the pandemic.

But even before the pandemic, the refinery business had been suffering from what they call an uneven playing field in terms of taxes. Rep Joey Salceda, chairman of the house ways and means committee explains:

“Under current law, we tax both crude and refined petroleum. In the process, billions of pesos get stranded in VAT credits because our tax administration is not yet efficient. That is cash that the refiner is unable to use to average down when global crude prices are cheap. Direct importers do not have that problem. We are rewarding direct importation even if they produce less gross value added than crude oil refining. That doesn’t make sense to me,” Salceda said.

“We are, in fact, the only major country in the region to treat crude oil and refined petroleum products the same way, in tax terms. The best model, of course, is Singapore, which ring fences refiners and only taxes them once you remove oil products from the licensed area. That makes perfect economic sense,” the House tax panel chair explained.

Oil refiners import crude oil that will be processed into finished products. The imported crude is subject to 12 percent VAT payable to the Bureau of Customs upon the crude oil’s arrival. Finished petroleum products are subject to excise tax upon lifting from the refinery.

Oil refiners are not able to recover the total input VAT paid on crude oil importation since refining yields only range from 90 to 93 percent by volume. Thus, the output tax from the yield would normally be smaller than the input tax originally paid.

On the other hand, imported finished petroleum products are subject to VAT and excise tax based on the total landed cost payable to BOC upon the arrival of the finished petroleum products.  Oil product importers can pass on VAT and excise taxes on total volume imported to their customers.

This uneven playing field was fixed by CREATE. One of its provisions states: “Crude oil that is intended to be refined at a local refinery, including volumes that are lost and not converted to petroleum products when the crude oil actually undergoes the refining process, shall be exempt from payment of applicable duties and taxes upon importation.”

Taxes will be payable upon lifting of the petroleum products produced from the imported crude. That’s like how mere product importers are taxed. So, the problem was fixed.

It was weird for Action for Economic Reforms (AER), supposedly a think tank, to oppose this provision and to urge the President to veto it. I respect the intelligence of some members of this group. Most likely, it was just plain laziness that made them issue a knee jerk statement without full understanding of the issues involved.

According to AER: “Exempting local refineries from duties and taxes is discriminatory and swings the advantage towards certain importers. Furthermore, oil refineries are not a part of the Strategic Investment Priority Plan which defines the activities qualified to receive incentives.”

Ano daw? What is discriminatory is the present rule before CREATE as Rep. Salceda earlier explained which gave tax advantage to product importers to the detriment of refiners. And if oil refining is not part of a strategic investment priority plan, it should be.

Besides, the AER position does not make sense. Sticking to the current unfair tax rule means the last remaining refinery will permanently close down. That means taxes the refinery and its allied industries pay to national and local governments will go as well. That’s zero taxes instead of some taxes under CREATE.

Additionally, Salceda says CREATE saved 3,000 oil refining jobs and enhances energy security as it leveled the tax treatment between direct importers and refiners of petroleum products.

Petron’s Bataan refinery is the only crude oil refinery left in the Philippines after Shell closed down its refinery last year. A recent investment of about $3 billion to enhance operating efficiency in Petron’s refinery will also be wasted, forever lost to the Philippine economy.

“Earlier in 2020, Petron was very transparent in saying they need a fairer tax treatment or they will have no choice but to shift to direct importation which will cost us thousands of jobs and hit our energy security. It is very difficult for a country that is a net importer of oil not to have a refinery, especially in times of disasters or conflict,” the House tax panel chair said.

“I said no to new tax exemptions that would erode revenues. But I couldn’t say no to provisions that made tax treatment fairer simply because they made economic sense,” Salceda said.

“We are one of the largest non-oil producing economies in the region. We expose ourselves to plenty of risks if we will disincentivize refining. That’s not good economic or national security policy, in my strongest view,” Salceda concluded.

At its average utilization in 2019, Petron’s refinery was able to supply about 30 percent of the total Philippine demand (using 2019 total Philippine average daily demand of 470.4 MMB). That gives us three months reprieve in case of an abrupt international supply breakdown.

I was looking at a map showing where we get our petroleum product imports. A lot is coming from China through traders, close to 100,000 of the 470,000 barrels per day we need, increasing our economy’s dependence on China.

China has built several big refineries and have been known to sell below cost of production to keep refineries running. But because the formula we use is based on Platts Singapore quotes, some importers are probably able to keep undeclared windfall profits.

It is also easy, given our unprotected coastlines, for product importers to cheat the government on potential VAT collection by smuggling their products in (industry estimate is as much as 40 percent). On the other hand, you can’t smuggle crude oil. A refinery’s production is here already and can’t avoid being taxed.

Then again, there are other issues in the refining business that will dictate on Petron’s final decision to restart the refinery or close it for good. A future column will tackle those.

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco