PETROJAM Limited, Jamaica’s only petroleum refinery, is shedding more light on how it arrives at its weekly ex-refinery prices. This follows complaints that while oil prices have been falling for six consecutive weeks Petrojam decided to increase its ex-refinery prices or give a smaller-than-expected reduction.

In an exclusive interview with the Jamaica Observer, Winston Watson, general manager of Petrojam, explains there’s a lack of understanding surrounding the pricing formula.

He said the first problem is that many Jamaicans are focusing on the wrong reference price.

For starters, Petrojam buys and sells finished products to consumers. Watson said “crude oil price is never used”, however the crude oil price is what most consumers tend to pay attention to.

To put things into context, Petrojam uses the US Gulf Coast reference price (USGC), which is the price most widely used for finished products in the western hemisphere. The more popular Brent and West Texas Intermediate (WTI) prices represent crude oil prices which are not used to calculate Petrojam’s ex-refinery prices.

This is important to note because there are instances when crude oil prices (Brent and WTI) are going down while finished product prices (USGC) are going up.

For example, refineries in the US Gulf Coast usually shut down in anticipation of a hurricane. In this case, the prices of finished products go up because there is a perceived impending shortage on the market. On the other hand, crude oil prices go down because the refineries which usually take crude oil products are closed.

Watson told the Business Observer “a lot of times that’s what’s happening”.

“When you hear people out in the market place say ‘Why doesn’t Petrojam just buy or sell at this price?’ Petrojam cannot buy or sell at that price because the market says this is how you must buy and sell, unless you decide to use subsidised prices,” he continued.

He stressed that anything that happens in the Gulf Coast will affect the price of finished products, which is the price Jamaicans should be most concerned with.

“When you hear ‘oil price’ on the news, typically or 99.9 per cent of the times they’re talking about crude oil — and you don’t put crude oil in your car. And that throws everybody in a tizzy because it’s two different markets,” he explained.

Another crucial component of Petrojam’s pricing mechanism is its price smoothing factor or market adjustment factor.

This is a stabiliser which cushions the market against adverse price shocks and is representative of the practice of a partial pass-through of changes in USGC prices.

Based on this mechanism, prices are adjusted within a defined band of plus or minus (+/-) $4.50.

The chart below is a comparison of the movement in market prices (that is the US Gulf Coast reference prices) for gasoline, diesel and ultra-low sulphur diesel. Petrojam’s price movements, represented by the orange line, are far less erratic than that of the market due to the presence of the market adjustment factor, which shields customers from price shocks.

As shown in the chart, the price movements to market do not exceed $4.50.

This explains the recent increases of $4.50 that have been announced by the refinery over the past few weeks, and in those cases Petrojam has been temporarily absorbing the difference.

Now that the prices of petroleum products have started to decrease, Petrojam’s policy is that the company must start to recover the amounts that were temporarily subsidised, using the same smoothing mechanism. Petrojam emphasised this is not an immediate recovery, but is recovered over a period.

The table below illustrates the weekly product price movements of USGC vs Petrojam from February 3 to August 18.

1 on May 19, Petrojam stayed within its defined band and only increased its ex-refinery prices by $4.50. It means Petrojam was not passing on the full price increase to Jamaicans. Notably, when prices went down by $7.76 on May 26 Petrojam lowered its ex-refinery prices by $0.25. The general manager explained that “When you see the prices jump, we don’t say it loud but you don’t see it. We have a policy that says ‘The price to the consumer must not move more than $4.50.’ So when it goes up by $20 you only see $4.50. Conversely, if it comes down by $20 I have to take back that $16 that I gave you last week but I only take back $4.50 [at a time], I don’t take back $16 [at once].

“Over the period we try to get it back so that the market adjustment remains as close as possible to zero.” He said this strategy prevents consumers from experiencing extreme shocks in the market.

“That number we came up with [plus or minus (+/-) $4.50] is based on experience. Over time we realised that price [adjustments] were typically within that range and that allowed us to give to the market and take from the market without causing any major disruption. The truth is, you could get a new board that says let’s make it $5, or let’s go $10, but then you say to yourself if you have a $10 spread you could pass on higher price shocks because it would be within the band.”

The Petrojam general manager further explained that it’s a two-tiered system where the inner band is $3.00 under normal circumstances but the unprecedented circumstances have caused Petrojam to use the outer band of $4.50.

So what’s the alternative?

Watson disclosed “You can do daily pricing and do away with the smoothing mechanism or you subsidise it with a fixed number. So the Government could just get up tomorrow and say gas price is $250 a litre no matter what’s happening in the world. In that case, the marketing companies would say, well it’s costing me $300 so you [the Government] will have to give me back that $50, and the Government would have to do that. That is what happens when you have a fixed-price regime, and that happens in some countries even today. But, I believe the alternative is worse.”

He said “We can’t give you what you think it should be, we give you what we know you’re entitled to so [that] we also get back what we were preventing you from seeing in the first place — and that is why you don’t see a massive reduction.”

In the meantime, the weekly ex-refinery price increase/decrease is not a one-man decision.

There is a pricing committee which meets on a weekly basis and sets the ex-refinery prices.

The pricing committee consists of: Petrojam’s general manager, the chief financial officer, the logistics and marketing manager, the supply optimisation advisor, the financial treasurer and budget planner, the chief accountant, the cost accountant, a representative from the Ministry of Science, Energy and Technology, a representative from the Ministry of Finance and the Public Service, and a representative from the Office of Utilities Regulation.

Watson said “We have very robust discussions. At the end of the day, once you look at what’s happening in the market we pretty much come to a consensus every time.”

Furthermore, he pointed out that the market is deregulated. “We are not the sole importer of fuel in Jamaica and neither can we stop anybody else from importing.” This means that other corporations like Rubis, Total, GB and West Indies Petroleum are allowed to import finished products using the same USGC reference prices.” Watson stated that those companies add their own mark-ups and are selling on the local market alongside Petrojam.

At the same time he highlighted that the Russia-Ukraine war continues to take a toll on the market.

“The war machines tend to use finished products. They use diesel a lot and jet fuel for the fighter jets so the price of those products tend to jump up [whenever there is a war] so you get both crude and finished products prices going up,” he explained. “The refiners are going to make a margin so you find that it will start to go up.”

Looking ahead and commenting about the direction of petrol prices, Watson said “I don’t think things are going to dramatically come down.” He said it’s all going to depend on what’s happening with the war in Ukraine as well as whatever the rest of the hurricane season has in store.