PRESENTATION TO PARLIAMENT PORTFOLIO COMMITTEE ON ENERGY

1. PRESENTATION TO PARLIAMENT PORTFOLIO COMMITTEE ON ENERGY FRA PERSPECTIVES ON THE FUEL RETAIL INDUSTRY IN SA 24th July 2013 Mr. Reggie Sibiya, CEO of Fuel Retailers Association

2. Agenda

3. Consumer Prices & Input Costs Industry Survival & Security of Supply Social issues including HDSA Empowerment Balancing act – the Regulator In managing the industry, it is important not to promote one national priority at the expense of others. The biggest challenge remains as regulatory uncertainty. Until RAS is concluded, we are not sure how retailer margins will affect the sustainability of the Fuel Retail Industry

4. Franchise Agreements Petroleum Products Amendment Act Consumer Protection Act The are a number of the policy and legal instruments governing this sector National Environment Management Act

5. The Fuel Retail industry supports 4500 SMMEs and over 70000 Jobs 40% of Sites are Retailer Owned, 60% are Company Owned

6. Liquid fuels industry regulatory framework The 1998 White Paper on Energy Policy (EWP) advocated for a liberalised liquid fuels industry but recognised that the liberalisation process would need to go through a number of phases before the industry can be finally liberalised Encouraging appropriate investments in local petrochemicals sector; Empowerment of historically disadvantaged South Africans Encouraging SMME participation in the sector Job Creation

7. Petroleum Products Amendment Act has created a number of opportunities for retailers • Licensing all petroleum activities • Prohibits vertical integration (Partially) • Introduces a balance of power between retailers & wholesalers • Enforces arbitration • Special provisions for • Empowerment – Charter was annexed to the Act • Full service (protection of jobs) • SMME development • The proposed RAS pricing framework could bring better value for retailers, but government intervention is critical to ensure this happens. - Retail margin should include an explicit component for fuel-related asset owner’s return and asset operator’s return.

8. The existence of regulated and unregulated price points within the same value chain puts retailer margins under pressure Retail Wholesale Petrol Unregulated Regulated Pump Price Diesel Unregulated Unregulated Regulated Maximum Price LPGAS Unregulated

9. The Retail Margin is the most contested portion of the value chain between Retailers and the Oil Companies (July 2013)ULP 93 INLAND: R13.00/Litre 24% Taxes Distribution & Marketing 10% 7% Retail Margin Basic Fuel Price 59% In the bigger scheme of things, the retail margin is the lowest share of the pump build up price

10. Company–owned site : Split of costs and returns in the current RAS Retail Margin of 130.1cpl

11. The Entrepreneurial Margin allocated by DOE is not the actual realised on the ground • The value that accrues to the retailer is not as a high as is it may seem • There are a number of “vultures” waiting for the “kill” • Unregulated Costs vs. Regulated Margin (Bank Charges, Credit Card Costs, Oil Company Rental/Franchisee fees) ALL of these costs are driven by Pump Price increases as they are based on percentage of turnover whilst cost allocated are based on fixed cents per litre

12. SMME DEVELOPMENT The EWP envisaged “the preservation of retailing activities for small and medium businesses” and the “preservation and promotion of formal sector employment.” To give effect to this EWP policy statement, certain prohibitions relating to the sale of petroleum products were included in the Act, namely a prohibition on vertical integration in the petroleum industry (to promote small business in the retail industry) and on self-service at retail fuel outlets (to protect the jobs of pump attendants). One of the objectives of the Petroleum Products Act of 1977 (as amended), is to promote development of SMMEs in the sector and the retailing sector presents that opportunity and hence the prohibition stated in Section 2(A)(5)(a) of the Act that states “No person may make use of a business practice, method of trading, agreement, arrangement, scheme or understanding which is aimed at or would result in - a licensed wholesaler holding a retail licence except for training purposes as prescribed, but excludes wholesalers and retailers of liquefied petroleum gas and paraffin”.

13. Pricing is part of the Bigger Picture Although Sections 2 A (5) (a) was included in the Act, it is very clear that the prohibition alone would not achieve the policy objective of SMME development in the petroleum sector and that the pricing methodology would have to be reviewed to support that policy aspiration. The MPAR pricing methodology was incongruent with this objective and hence the introduction of RAS, which was intended to separate wholesaling assets from retailing assets SUSTAINED RETAILER PROFITABILITY (ENTREPRENEURIAL COMPENSATION) The pricing model needs to be congruent with the other objectives of the Act. The Act prohibits the wholesaler from operating the business and yet pricing allows wholesalers to earn a profit relating to operating the business.

14. Feedback regarding Operators Return in the Final RAS Recommendations - by DOE appointed Consultants(IPSR) Implementation of the margin mechanism Summary of Concerns • BSS model makes no provision for an appropriate return on the retail activity i.e. retailers will only be compensated by cost recovery. • BSS model would challenge the prohibition of vertical integration as Oil Companies will seek to share the retail margin by extracting a return on their assets via unregulated increased franchise and/or rental fees. In order to address these perceived issues it is proposed that the inclusion of a return on retailing activities be explored and that the future margin be split between a return on assets and an operating return). { BSS = Benchmark Service Station} IPSR Response • The BSS model follows the Bates White regulatory formula. This makes full provision for a fair return on owning and operating a business. Note that the return on assets should not be perceived as a bare return for investors providing capital – the WACC reflects the risk and reward of owning and operating a business enterprise. • The proposal to split the investment margin into investor and operator elements is outside the scope of the terms of reference of ME 686. However, in the interests of clarity it is noted that should the DOE consider splitting the investment margin into investor and operator portions, this split could not simply reflect the current two elements of the Bates White formula (return on assets at the current WACC, and cost recovery). This would be incorrect as all the return for entrepreneurial risk would pass to the investor. { ME686 = project name whose outcome is RAS) ME 686 14

15. CHANGES IN PRICE REGULATIONS – NEGATIVE IMPACT ON RETAILER PROFITABILTY • LPGAS MAXIMUM PRICING • CARDS PAYMENT REGULATIONS - Credit Cards- Regulatory lag on Cost of Cash • DEREGULATION OF DIESEL – Oil Company Diesel Cards • NEXT IN LINE – ENTREPRENUERIAL MARGIN ?

16. Transformation agenda • Section 2C of the Act seeks to “promote the advancement of historically disadvantaged South Africans.” • The protection of Entrepreneurial Margin in RAS margins is crucial for HDSAs who often come to the system highly geared. • Such protection would give confidence to funders( Banks) who are currently waiting to see the outcomes. Funding is the most critical part of transformation agenda and funders need assurance of sustainability.

17. Security of supply • The key objective of the Petroleum Products Act is ensuring availability of liquid fuels in all corners of South Africa. The only way that the supply of liquid fuels can be assured is through ensuring the sustainability of the retailing sector, which presents the direct interface with the majority of the liquid fuels consumers, including on road commercial consumers. Most of the petrol stations within the North Wales coasts’ holiday area have disappeared in recent years. Many are now selling caravans or planning permission applied for housing. Holiday makers who are returning a year later are at a loss as to where the nearest petrol station is. When all of the independent filling stations (with their staff full of local knowledge, personality and skills) have gone, then the supermarkets can (and will) stop subsidising the fuel and charge what they like. Just remember this next time you drive past the local independent petrol station to save 1p/litre at the supermarket. John, Colway Bay, North Wales

18. Our problem – Vertical Integration in a Regulated Activity Wholesalers continue to enjoy profits from the retailing business, through rentals and franchise fees, which amount to a prohibited practice in terms of the Act. Retailers believe that by definition(retail license ownership), it is only business owners who must share any profits accruing to the retail business. In enjoying profits relating to running the retail business, wholesalers are in fact de facto retail business owners.

19. Conflict between Franchising and Regulation • “The big issue here is , once a margin is set, how that margin is shared between a retailer and wholesaler is currently a function of the franchising (or any other contractual) arrangement between the two players. • In FRA’s opinion, if this is allowed to continue, many service stations will go under over time or we will create an environment where retail businesses are still largely controlled by Oil Companies via “glorified managers”, earning whatever Oil Companies feel its appropriate for them. • This is against the spirit of SMME development and true empowerment we are seeking in the Fuel Retail Sector.

20. System envisaged for retailing industry sustainability • Removal of retail assets from the wholesalers , to assist with the delivery on most of 2003 Petroleum Products Amendment Act’s objectives • The system must offer a better chance for survival of new entrants (HDSAs) • It must provide the correct investment message to the industry ( right now that message is not very clear) • Efficient investment must be made in the retailing network ( i.e. converting all sites to Retailer Owned, Retailer Operated (RORO) sites – eliminate overcapitalisation and vertical integration). RAS model was based on a RORO site and it makes sense to align the retail structure with the pricing model. • Promotion of efficient retail network development (Licensing and overtrading)

21. Our Proposition as Fuel Retailers Association • Retailers believe that Petroleum Products Act provides the necessary tools to change the lives of retailers positively but the Act needs to be fully implemented, including review and enforcement of all prohibitions provided for in the Act. • Although the Minister, directly and indirectly, sets margins that are levied on petroleum products, the margins are themselves not controlled. This means that in actual fact, a wholesaler can sell fuel to a retailer or any other buyer at a price higher than the wholesale list price, whilst the retailer is held by the regulated retail price. • To give effect to the prohibitions envisaged in the Petroleum Product Act and ensure the continued viability of service stations without placing undue pressure on retailer margins, it is proposed that Minister regulates maximum wholesale prices over and above controlling the fuel retail price. The control of wholesale list prices will ensure that wholesalers do not end up enjoying profits from retail margin, at the expense of retailers. • In the interim the urgency is to regulate the Entrepreneurial margin, to protect small businesses, jobs and ensure a sustainable transformation and security of supply.

22. SUMMATION • SUSTAINABILITY: PRICING- Pricing Regulations- Prohibition of Vertical Integration- Changes in pricing with negative impact on retailer profitability • TRANSFORMATION- Role of Pricing • SECURITY OF SUPPLY • SUSTAINABILITY:LICENSING ( Brief comment on presenting) • COMPLIANCE ( Brief comment on presenting)- Regulation R731- Co-ops

23. LEVEL PLAYING FIELD A level playing field is a concept about fairness, not that each player has an equal chance to succeed, but that they all play by the same set of rules.A metaphorical playing field is said to be level if no external interference affects the ability of the players to compete fairly. Government regulations tend to provide such fairness, since all participants must abide by the same rules. Examples of such regulation: building codes, material specifications and zoning restrictions, which create a starting point / a minimum standard --- a "level playing field

24. Fuel Retailers’ EXPECTATIONS LEVEL PLAYING FIELD Fairness, Same set of rules, Players compete fairly Government regulations/interventions

25. Q&A