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 KAZAKHSTAN International Business Magazine №3, 2002
 International Experience of Governmental Regulation of Petroleum Products
ARCHIVE
International Experience of Governmental Regulation of Petroleum Products
 
Introduction
 
Two-tier pricing policy proposed by the Government of Kazakhstan (GOK) was met with resistance by some foreign oil producers who claimed that their contracts permit exporting the equity share of their oil production at unrestricted prices and volumes as they saw fit, meaning at the highest achievable prices. In any event, Kazakhstan faces the problem of necessity to hold domestic petroleum product prices at acceptable levels, especially for the agricultural sector where substantial volumes of products are needed twice a year, during sowing times and harvests.
 
The GOK is faced with an apparently intractable policy dilemma in its crude oil and petroleum product market sector that is brought on by two mutually exclusive policy objectives. On the one hand, the Government seeks to maximize its crude oil revenues, meaning that it has an interest in achieving the highest possible crude oil prices, especially for crudes destined for export markets. At the same time, the Government wishes to maintain low petroleum product prices at its domestic markets. Since these products are in large part produced from domestic crude oil, that policy objective calls for low crude oil prices. The two objectives, high and low crude oil prices, are, of course, mutually exclusive.
 
In an effort to overcome the crude-oil pricing dilemma, an attempt had been made to create in effect a two-tier crude oil pricing mechanism. A Draft Petroleum Products Law, first submitted for review to the Parliament in April of 2001, proposed to establish minimum throughput volumes for Kazakhstan refineries. While the Draft Law did not specify so, it was widely believed that oil producers would have to be directed to provide the required crudes to the refineries, given their chronic inability to attract needed feedstock. It was believed, that the crude oil purchasing pric e at the Kazakhstan refineries would be below the netbacks from oil export.
 
The Draft Lsaw did not mention prices, but it was generally assumed that they would be below net-backs. If prices of crudes delivered at refineries were competitive with net-back export prices there would be no need to direct the delivery of crude oil. The consideration of the Draft Law led to the question of how petroleum and petroleum product markets function in other countries. Accordingly, the then Vice Prime Minister and Minister of Energy and Mineral Resources, Mr. V. Shkolnik, requested USAID to assist in answering the question. USAID assigned the task to the NRMP, led by PA Government Services, which recommended an overview of the regulation of petroleum products markets in three countries. The NRMP proposed that the United States, Germany and Russia be selected for the country reviews.
 
The United States was suggested because, of all industrialized nations, it has among the least intrusive policies in the petroleum sector. It is, to use a metaphor, the gold standard of market-oriented operations in general, and of petroleum market operations in particular. Indeed, its record in the petroleum and petroleum products market is impressive. The country consumes nearly 20 million barrels per day (MM b/d) of petroleum products, about half of which it imports, in part as crude oil (8.6 MM b/d) and in part as products (2.2 MM b/d, net). At present, 86% of the total capacity of all existing refineries is used in the United Stated, which amounts to 16.7 MM b/d. Notably, local or foreign crude oil supplies to these refineries face no government restrictions.
 
There was, however, another good reason to include the United States among the target countries of this study. During a period of national stress, the United States temporarily abandoned its free-market policies, following the Arab oil embargo of 1973/74. The petroleum market was quickly engulfed in severe market dislocations, with some regions experiencing acute shortages while others had surpluses of various petroleum products. Small and simple refineries were constructed in pockets of chronic shortages, where they achieved monopoly status and reaped enormous profits, only to disappear after the market returned to normalcy after 1981. Looking back on the period of U.S. oil price controls, it would be safe to say that the country would not want to go through such a phase again.
 
Germany is noted for its very efficient, if high-priced, petroleum product market. The unusually high prices of petroleum products in Germany, however, are largely a matter of the Government’s tax policies. One reason for the inclusion of Germany as a target country in the Kazakh context is that following the re-unification of what used to be the German Democratic Republic (East Germany) and the Federal Republic of Germany (West Germany), the re-unified country was faced with a two-tier petroleum market. How and at what sacrifice these two diametrically divergent markets were brought together, it was felt, could be of some interest in Kazakhstan.
 
Russia was suggested, because it shares many of the characteristics of the Kazakh petroleum market. Like Kazakhstan, Russia is a significant exporter of crude oil. It also has a domestic petroleum product market that it does not wish to expose to any spill-over effects from the high-priced international product markets to which it finds itself suddenly linked. It stands to reason, of course, that a country that is awash in petroleum resources, would not want its citizens to be burdened with prices that reflect shortages elsewhere in the world and that, in addition, are artificially inflated in many of the net oil importing countries by extraordinarily high levels of taxation. The issue with regard to Russia, then, is the measures they employ to try to maintain lower petroleum product prices.
 
Main Conclusions
 
Neither feedstocks nor refining products are subject to price or volume controls in the United States or Germany. Prices and volumes in both countries are set by the interplay of various competitive forces. The U.S. refining industry has matured and has more or less settled into a static performance pattern. There are not likely to be any new refineries built in the foreseeable future. Its 174 refineries produce some 14-15 million barrels per day of petroleum products, far more than any other country in the world. Still, the logistics of supplying crude oil to U.S. refineries and of distributing their products are done by following market (pricing) signals, without any government intervention.
 
The German refining industry is as competitive as the U.S. industry, if not more so, in part because of the easy access to and distribution of refined products from other countries that compete directly in the market with the products coming from domestic refineries. The refining industry at large is in a depression, characterized by razor thin profits and a surplus of sales outlets.
 
In Russia, the pricing situation is more complex. While there are no direct controls on either feedstock or products, there are various governmental policies that affect crude oil and oil product prices indirectly. For example, Russia pursues a policy of isolating its domestic market from the spill-over effects of high prices abroad through the imposition of a substantial export tax which varies with world crude oil prices. In addition, crude oil producers may be granted additional export quotas depending on their monthly supplies to Russian refineries.
 
If a company agrees to serve governmental procurement orders at lower prices, it becomes eligible for guaranteed additional quotas. For example, while exports have been averaging around 30% of production nation-wide, Lukoil and Yukos have been able to achieve exports of around 40% under this policy.
 
Finally, the Russian government may from time to time impose the so-called “balance orders”, that is, compulsory provision of certain oil products to the domestic market, accompanied by limiting the export of crude oil and deficient oil products.
 
Licensing and permitting procedures for operating and new refineries in all three countries generally have one thing in common: they are all subject to overlapping oversight by different agencies. The two dominant oversight areas are the environment and safety. For the construction of new refineries, not likely in the foreseeable future in either the U.S. or Germany, there are no specific regulatory guidelines. Instead, construction plans are developed independently and submitted to licensing agencies for review and acceptance or, if necessary, modification. These plans are reviewed for compliance with environmental and safety standards. One way or another, public input is required in the licensing process. The re-certification of ongoing refinery operations follows similar procedures.
 
Environmental protection with respect to refinery operations has always been a matter of considerable regulatory attention in the United States and Germany. In Russia, environmental considerations were at times subordinated to concerns regarding production, but this is changing now.Like environmental issues, safety concerns are addressed in all three countries by federal legislation, but enforcement of safety standards is largely a local matter. In the United States and in Germany, local safety standards must be at least as stringent as federal standards, but they can be and, depending on localities they are, more stringent. In Russia, the federal safety standards are law throughout the country. No local deviations are allowed.
 
As to export and import regulations, there are absolutely no restrictions on the free importation or exportation of crude oil or petroleum products in the United States and Germany. Of course, certain documents must be completed to accompany crude oil and oil products across the borders, but these fulfill statistical and tax collection functions. They are not permits subject to discretionary rejection by the authorities.
 
Russia does have a permit system for trans-border shipments. No import licenses are required for crude oil, and the requirements for the importation of oil products are minor (petroleum products, for example, must be in compliance with Russian quality specifications). However, export licenses are a different matter. They are required for both crude oil and oil products. As mentioned, export quotas are used as a policy tool to control domestic product prices.As to taxes on refinery feedstocks, taxes in the United States include excise taxes, import duties if applicable, sales taxes and special taxes such as environmental taxes. In Germany, they include a 16% import turnover tax, a mineral tax, and a so-called ecotax, to name the most important ones. The Russian tax code has undergone amendments as recently as December of 2001.
 
For example, on January 1, 2002, the profit tax rate was reduced from 35% to 24% and a new mining tax was introduced to replace a crude oil excise, a mining base replenishment tax, and royalty.
 
The following limits for export tax duties were set for crude oil:
• 0% for an average price of Urals of up to $109.5 per ton (about $15 per barrel) existing during two preceding months on the Mediterranean and Rotterdam markets;
• not exceeding 35% for an average price of Urals of $109.5 to $182.5 per ton (about $25 per barrel) existing during two preceding months;
• not exceeding 40% if an average price of Urals existing during two preceding months goes up to $182.5 per ton or higher.
 
With respect to petroleum products, the United States has lower taxes than just about any other industrialized country, and Germany has among the highest taxes. As a percent of the price of regular unleaded gasoline at the filling-station pump, the U.S. taxes amounted to 25.6%, compared to Germany’s 74.1%.
 
In the United States, taxes are collected by the federal government and by state and local authorities, and they are in part dedicated to meet specific expenditures, whereas in Germany, most of the petroleum taxes go to the general revenue fund. In Russia, all taxes are collected by the Ministry of Taxes and Revenues, and all go to the general revenue fund.With respect to reserves held to meet national emergencies, such as embargoes or the interruption of world markets through war, both the United States and Germany are signatory states to the IEA Agreement that requires holding reserves in crude oil or in petroleum products for a minimum of 90 days of net imports. As a major net exporter of crude oil, the need for holding such reserves is less compelling in Russia. Nevertheless, Russia does hold general emergency reserves to cover a variety of functions, including military emergencies, civilian emergencies, and assistance in regulating markets.
 
Neither of the three target countries has any price or volume controls on storage operations for crude oil or petroleum products.
 
Storage facilities in all three countries are licensable facilities. While their specific licensing requirements vary, they all generally include strict environmental and safety controls, and their licenses all are to some degree secured with public input, perhaps more so in the United States and in Germany than in Russia. The environmental concern on storage facilities in all three countries is primarily focused on air pollution through escaping hydrocarbon vapors, and on ground water and soil contamination from liquid hydrocarbons coming from leaks in tanks or pipes. In the United States and in Germany, tighter environmental standards are permissible locally, while Russia adheres to one nation-wide environmental standard. The principle of federal standards enforced in whole or in part through local authorities also holds true with regard to safety standards. The report deals with road and rail transport, which is essentially unregulated in the United States and in Germany, at least as far as prices and volumes are concerned. The fact that U.S. road and rail transport is unregulated comes as no surprise. All trucking and all freight transport by railroad is in private hands in the United States, and subject to fierce competition, with each other and with alternative means of oil transport such as barges and pipelines. In Germany, the railroad was privatized in 1994, and a new company in charge of freight shipments, DB Cargo AG, is locked in intense competition with competing shippers which, in Germany, includes pipelines, barges, and trucks, all three of which operate within a well-developed transportation infrastructure.
 
In Russia, rail transportation tariffs are subject to state regulation, whereas motor transportation tariffs are not regulated. As in other areas, the policy-setting body for railroad tariffs in Russia is the Federal Energy Commission.
 
In all three countries, there are multiple agencies involved in overseeing petroleum transportation activities and licensing procedures. License requirements generally deal with safety and environmental issues. As to safety, this involves maximum weight considerations, competence and health of personnel, and response capability in the event of an accident while carrying flammable or hazardous materials. Environmental concerns mostly deal with leaks and spills.
 
There are no price or volume controls on filling stations in any of the three countries. In the United States and in Germany, the selling of motor fuels is a fiercely competitive business, especially in Germany which is currently facing a glut of filling stations. It has been estimated that, of the 16,000 filling stations currently in operation in Germany, some 3000-4000 will be retired over the next decade or so.
 
All three countries regard filling stations as licensable facilities, for obvious safety and environmental reasons. Licensing requirements and procedures for obtaining a license for filling stations vary, of course, among the three countries, but they all emphasize in one way or another environmental protection and safety. The safety requirements for filling stations in all three countries appear to be more stringent than those for regular storage facilities, given the placement and storage of explosive material in proximity to populated areas.
 
Environmental concerns in all three countries focus especially on hydrocarbon vapor leaks into the atmosphere and on liquid hydrocarbons leaks into streams or into the subsoil. Spill prevention and leak detection are the principal environmental tools at work.
 
Conclusion
 
The United States and Germany have a settled political environment with stable regulatory regimes. By contrast, Russia is going through a process of political and regulatory reforms that are likely to make the findings of this report somewhat tentative and, perhaps, obsolete in a short period of time.
 
An Overview of International Practices on Petroleum Products Regulation (United States, Germany, Russia) was prepared by the USAID Central Asia Natural Resources Management Programm in response to a request by the Minister of Energy and Mineral Resources, Mr. Vladimir Shkolnik, to the United States Agency for International Development (USAID) dated October 16, 2001.
 
The final version of the report was submitted to the Ministry of Energy and Mineral Resources in May, 2002. At the request of the Ministry a seminar on international practices on petroleum products regulation was held in Astana on July 17. The seminar was attended by representatives of the Ministry of Energy and Mineral Resources, Ministry of State Revenues, Ministry of Natural Resources and Environmental Protection, Agency for Regulation of Natural Monopolies, Protection of Competition and Small Business Support, Oil and Gas Dispatch Center, CJSC NC “KazMunaiGas”, “Helios” company and JSC Hurricane Kumkol Munai-ShNOS.
 
The purpose of the report was to review petroleum product regulations and policies in the United States, Germany, and Russia and to determine how the refineries in those countries are regulated and how they go about acquiring their crude-oil feedstock. A particular focus was whether they are subject to governmental allocations in meeting their crude-oil needs or in the production of petroleum products. Other sectors to be reviewed in this overview were crude oil and petroleum product storage, crude oil and petroleum product transport (other than by pipelines) and petroleum product retail operations at filling stations.
 
This report was meant to be an objective review of petroleum market operations in the target countries, rather than a policy analysis. The focus was the factual information, without commenting on the policies that had shaped petroleum market operations or speculating on the motives that may have laid behind these policies. If anything of value was to come from this exercise for Kazakh policy makers, the information provided in this report had to be unbiased, so that the policy-makers could look at the information through unfiltered lenses and determine for themselves what, if any, lessons they might draw from it.


Table of contents
Invest in Astana!  Adilbek Dzhaksybekov 
Helios Means First!  Shukhrat Danbai 
Certain Environmental Aspects of the Activities of Subsoil Users  Aigul Kenjebayeva, Yuliya Mitrofanskaya 
Issiue Deductibility of Interest on Foreign Currency Loans  Bill J. Page, Gaukhar Iskakbayeva 
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