DoE – Wholesalers Transformation

meeting

4th May 2017 LFWA presentation : Impediments , opportunities and proposed solutions

to expedite meaningful transformation in the Petroleum sect

Key principal for regulators

The key principle driving regulators is that regulators regulate an industry and not a company.

(The regulator is not concerned about viability and performance of a particular company but that of an industry under its control. For instance, the fact that a particular service station located in a particular suburb does not have fuel or even the fact that all service stations belonging to a particular brand do not have fuel is not an issue that a regulator should concern itself with. Of concern to the regulator is whether the rest of the market is supplied or not.)

This principle however falls flat when it comes to controlled prices where consumer prices are based on average prices (as explained in LFWA submission ). In this case, if new investments are desired or participation by new entrants is desired, the regulator has to get involved.

Impediments- current Margins

For physical assets based petroleum activities, there are effectively two “businesses” operating simultaneously, namely 1) infrastructure ownership and operations (the landlord function) and 2) business operations (trading).

The South African petroleum products system grew from a position when major oil companies owned, operated and conducted business on their own assets. (In the limited cases when they didn’t own the assets, they controlled the income flow derived from use of such assets through long-term contracts entered with the owners of the assets, thus controlling the asset.)

In the past, for these market players, the distinction between the two businesses operating simultaneously therefore didn’t matter because effectively the landlord and the trader were one and the same person.

With the introduction of new Transformation players the need for specific ring fenced specific activities is paramount ( When the base line for cost recovery for moving hydrocarbons from “ point A to Point Z” is not correct then meaningful transformation is not possible).

Different types of wholesalers

Integrated wholesalers 7

Independent wholesalers +/- 45

Trading brokers +/- 1700

Key Understandings: Independent wholesalers

Independent wholesalers have peculiar challenges emanating from the markets they serve, markets which would not receive uninterrupted supply of petroleum products would it not be for independent wholesalers.

The restructuring of the industry came with serious challenges to independent wholesalers- the key problem is primarily because of the delinking of the distribution costs to the lower demand, non- urban and distant areas from distribution margins. This challenge comes from the continued regulation of certain petroleum products prices and margins

2nd storage / handling: there are different sizes of depots; as such they have a different environment for investment; most of the small depots are owned managed by Independent wholesalers

Independent wholesalers serve the Non-urban areas; these are areas where the Oil majors have withdrawn from the market N.B. Are areas of low demand – far from key supply areas, that require additional transport and storage and handling.

The Oil Majors withdrew from these areas due the under- recovery situation caused by the pricing cross subsides in the current pricing model, these challenges are not company challenges but industry challenges. (This behaviour of the major Oil Co’s was driven by the need to protect shareholder’s returns.)

Current rebate / discount structures post RAS (Previously (1998 to 2003) Legislative – Regulatory changes appear to have been made by using a method of amending previous rules. (Amendments to the PPA/ MPAR amended/ RAT plan Amended) rather than rethink the intention of regulation including Transformation.

Fuel Supply Chain (refinery to motorist) via

wholesalers collecting at Terminals

TERMINAL

SEC

STORAGE

“Q” –double

handling

DEPOT

SEC

STORAGE

17,4c/l

SECONDARY

DISTRIBUTION

17,9c/l

Retail Site

176,4c/l

Oil

Company

(Refining

wholesaler)

The two economies – Independent wholesalers operate in

2nd economy I.E. Non Urban (rural /Outlying) areas Motorist

PIPELINE

PRIMARY

TPT MDZ

study

ROAD

PRIMARY

TPT MDZ

study

The retailer

pays the zone

retail list price

.

The motorist

pays the zone

retail pump

price

Average costs for Storage and Handling and distribution costs in volume per month – the 50

depots as per RAS.

0

5

10

15

20

25

30

35

40

0 20 40 60 80 100 120

S+H C/l

Distribution costs c/l

( X axis volume in million litres / y axis costs in cents per

litre)

Independent wholesalers Challenges

White paper – stimulate growth( re-regulate industry to achieve higher levels of competition and unrestricted market access)

Market “short” in product

Deliberate cross subsidies between Urban / Rural – outlying areas ( changes in behaviour – unintended consequences)

Current rebate / discount structures post RAS (Previously (1998 to 2003) Legislative – Regulatory changes appear to have been made

by using a method of amending previous rules. (Amendments to the PPA/ MPAR amended/ RAT plan Amended) rather than rethink

the intention of regulation.)

What happens when Independent Wholesalers set up.

Without Financial sustainability there will be no real transformation (PLFC, BBBEE Sector Codes Alignment-steering committee )

The behaviour of the Integrated marketers was driven by

the need to protect shareholders returns.

The intentions of the current legislation , regulations are

good ; it is in the implementation that there are gaps.

A better understanding of the difficulties for independent

wholesalers to import fuel is needed.

The question must be asked – Is there enough margin in the

chain ?( IW’s don’t have control of the full cost recovery

model)

RAS introduced for Petrol only ( separate policy discussion

needed for Diesel – IP)

The LFWA has critical knowledge that it wishes to share

that we believe can assist the industry

Solutions to be addressed at PLFC alignment

to BBBEE policy framework “working group”

State of competition

Access to infrastructure

Cost of entry

Access to supply

Policy and legislation

RAS

Skills and training

Industry transformation challenges

State of competition

Independent Wholesalers cannot compete aggressively with Oil majors as they are dependent on them for supply

Independent Wholesalers are only accommodated in niche market if they can provide new customers – e.g. due to B-BBEE status

Branded distributors are locked into the Oil Majors (Refiners) value chain with exclusive contracts

Access to infrastructure

All new Independent Wholesalers are BBBEE compliant and struggle to access the national infrastructure used by the Oil Majors at different stages of the supply chain

Linked to this struggle to access the national infrastructure the “access to supply constraints “gives the Oil majors unnaturally high market power position

Loading process at the Oil major’s depots are tedious with 24- 48 hours’ downtime before BBBEE companies can load fuel

Shortcomings in the current MDZ systems create further serious trading constraints

Industry transformation challenges

Cost of entry

The infrastructure Capital costs for new independent wholesalers is high (depots /

trucks)

The working capital costs for new independent wholesalers is high (refiners want

to be paid up front customer want credit terms)

Banks don’t understand the regulated markets in SA

Competition is usually on service – security of supply

Petrol regulated prices / Diesel – IP not

Define Mechanism for free economy and Structure to break current constraints

Aggressive strategy for financing -must be linked to the share skills knowledge and

mentorship (Line of sight control)

Industry transformation challenges

Access to supply

Not enough procurement of crude oil and refined products is done by BBBEE wholesalers

The Major Oil co.’s (refiners) control the supply of liquid fuels

The Major Oil co.’s own and operate most of the petroleum facilities: limited or non- committed capacity is provided to Independents

The ability to distribute to the inland regions is challenging given the major Oil co.’s control of access to the pipeline via their refineries

Independent wholesalers have great difficulty in gaining access to port facilities in South Africa (SBM – available storage capacity is extremely limited.)

The Oil Majors do not deal directly with new entrants in the wholesale distribution markets, because they don’t sell sufficient volume

There are different types of independent wholesalers – each has a differing channel of access to the Oil Majors

Oil Majors prioritise their own supply over independent wholesalers in the event of fuel shortages

Industry transformation challenges

Access to customers

The Oil Majors have market power and as such discount to the market on

similar terms – Independent wholesalers compete for customers on the basis

of value added (such as reliability and timeliness)– this is at the Independent

wholesalers expenses

The widespread use of supply agreements and the vertical arrangements

entered into by Major Oil co.’s does allow some competition in Niche markets

but doesn’t allow for much competition elsewhere

Competition would be greater if all independent wholesalers had a negotiated

“refinery gate” pricing structure

Industry transformation challenges

Policy and regulation

Licensing encourages the entry of new players however the current unfair pricing mechanisms ( the two separate economies created ) linked to the lack of training and the transfer of skills and knowledge has created an environment where new entrants entering as Independent wholesalers are being set up to fail.

The current pricing practice of one average for Secondary storage and secondary transport is critically flawed.

The fact that more than 1900 wholesale licenses have been issued and our estimation that only around 10% are being utilized in their full capacity should be major cause for concern

RAS pricing system

The DoE change for the previous MPAR mechanism to Ras is flawed as this change is for petrol only

Skills and training

Specific knowledge of the workings of the Liquid Fuels industry, including the regulatory environment and tacit local market knowledge acquired through industry experience is essential for any new entrant ; this specific knowledge is also critical to attracting new customers

Going forward ; Key Understandings:

Independent wholesalers

Without Financial sustainability, there will be no real transformation

The industry has changed drastically over the last 20 years and we can expect

more of the same going into the future.

The intentions of the current legislation, regulations are adequate ; it is in

the implementation that there are gaps.

The PPA gives strong guidelines that are in 3 main areas (i) Consumer price

and input costs (ii) industry survival and security of supply (iii) social issues –

transformation agenda

Deliberate cross subsidies between Urban / Rural – outlying areas (changes in

behaviour created unintended consequences)

Radical Transformation

The LFWA has been propagating from day one that “When the base line for cost recovery for moving hydrocarbons from “ point A to Point Z” is not correct then meaningful transformation is not possible.

What does this mean ?

Currently the conflict is between the Refiner / Independent wholesaler. Regulations are needed to ensure that whoever performs the activity recovers : (1). Cost recovery / (2). ROI- storage and transport and (3). A bankable solution

PLFC alignment to BBBEE policy framework is necessary to ensure SA incorporated solutions / joint vision is agreed and that the required momentum is there to ensure meaningful transformation is achieved. (No one size fits all solution / differences in 2 separate economies created must be high-lighted (Urban vs non-urban)

Transformation agenda must be seen as overriding principal for all decision making Transformation is a National imperative.

IW’s have a great story to tell : e.g.

Mentorship programmes

Wholesale space – in place agency agreement = enterprise development

CALTEX EASTERN CAPE MARKETER (CECM)

1) Sabelo Xotyeni: A former business consultant employed by CECM was assisted to acquire a Caltex Branded site in Tsolo. This site has doubled its volume and a Fresh Stop will be included in the sites offerings this year.

Sabelo has been granted a 2nd outlet in keeping with CECM vision of Master retailers.

Sabelo takes over Tsolo N2 on 1 May 2017 with assistance from CECM.

2) Trevor Rahim: A former contract employee opened a Caltex branded site in Elliotdale in the Transkei region.

Trevor was allocated a 2nd site in Gcuwa (Butterworth) and commenced trading in October last year.

Caltex E Cape Contd.

3) also facilitated by way of enterprise development major refurbishments at the following outlets managed or owned by HDSA retailers:

- Ulundi Garage (between Mthatha and Port St Johns)

- Siyatha (Mdantsane East London)

- Edwards Garage (East London)

- Bell Motors (Queenstown)

4) Crusade Logistics: This BEE start-up company approached CECM to facilitate their entrance to the fuel transport industry.

CECM used its funds to purchase 2 new tractor trailer combinations.

These vehicles deliver fuel to CECM Eastern Cape sites.

Crusade have since grown their fleet to 14 movers and have returned a maiden profit.