Low oil prices and Sri Lanka’s lost opportunities

15 June 2020 12:30 am - 0     - {{hitsCtrl.values.hits}}



Lockdowns across the world have caused trade and travel to grind to a halt. The demand for oil has plunged and the prices have crashed; futures for West Texas Intermediate, a grade of oil, briefly turned negative, touching a low of minus US $ 40.32.

The negative prices resulted from a lack of storage space to hold the glut of crude caused by diminished consumption. Traders were willing to pay buyers to take oil off their hands rather than incur the costs of storage. Although the negative prices were an anomaly, in a world of collapsing prices, anyone with storage capacity would sense an opportunity.

Sri Lanka has a 101 oil tanks in Trincomalee, with capacity to store some 1.2 million tonnes of oil but any opportunity for storage is lost because the tanks are in disrepair.

The tanks were built by the British when Trincomalee was the main base of the Eastern Fleet of the Royal Navy, during World War II. The farm had 101 storage tanks built with one-inch thick steel sheets and the tanks near the harbour are enclosed by one-foot thick concrete rings. Each tank has a capacity of 12,100 tonnes. 

After the withdrawal of the Royal Navy, the tanks fell into disuse. The government, which paid the British compensation for these assets, found no use for them. No one in the country seemed to have any idea how to use them either, so the tanks were abandoned to the elements. Thieves have made off with some of the steel girders and piping but the tanks themselves, built to withstand Japanese bombardment, survived, probably only because they were too big to dismantle.

Can anyone be blamed for a lack of foresight? In 1957, no one could have predicted this turn of events but leaving something in a state of neglect is a failure of stewardship. If we are to progress as a nation, there are important questions on assets, their ownership and exploitation that must be understood. 

Stewardship refers to the careful and responsible management of something entrusted to one’s care. In a private company, the directors are responsible for ensuring that the organisation gets the best from its assets and uses them as effectively as possible. A government must exercise similar responsibility towards any asset it controls. 
A business’ profitability depends on how well its assets are utilised, just as a nation’s standard of living is determined by the productivity of its economy. Productivity in an economy is measured by the value of goods and services produced per unit of the nation’s assets: human, capital and natural resources. 

Productivity depends both on the value of a nation’s products and services, measured by the prices they can command in open markets and the efficiency with which they can be produced. What matters most is not ownership of assets but the productivity with which they are used.

It is productivity that allows a nation to support high wages, a strong currency and attractive returns to capital—and with them, a high standard of living. Sri Lanka’s leaders with their feudal mindsets have always assumed that wealth arises from ownership of assets. This is a mistake; the tale of the oil tanks is a good way to illustrate this fallacy.

Like Ceylon, Singapore also inherited a tank farm but allowed the foreign oil companies that were operating in the country to use them for storage and trade. Even during the OPEC embargo of 1973, when the oil prices quadrupled, the government of Singapore resisted the temptation to nationalise them. 

The OPEC embargo meant there was a global shortage of oil that threatened all countries. Had the Singaporean government decreed that the oil stocks could not be exported, Singapore would have had enough oil to last two years and could have ridden out the shock comfortably. 

Instead, the heads of the oil companies operating in Singapore: Shell, Mobil, Esso and BP, were informed that the Singaporean government would not lay claim over their stocks of oil. In an extraordinary crisis, reassuring investors that the government respected private property and would not sacrifice that principle for political expediency, created trust.

“The decision increased international confidence in the Singaporean government, that it knew its long-term interest depended on being a reliable place for oil and other businesses.” (Lee Kuan Yew)
Confidence led these companies to increase investments, diversifying into petrochemicals in the late 1970s and later to expand refineries further. By the 1990s, Singapore, despite having no oil, had become the world’s third largest oil refining centre and the third largest oil trading centre.

Contrast that with the experience of Ceylon. The assets of the Royal Navy were acquired in 1957 but then left idle. In 1961, the assets of Shell, Esso and Caltex, were nationalised to form Ceylon Petroleum Corporation. Apparently, the government believed that it could save foreign exchange if it imported and refined oil, instead of allowing the foreign companies to do so.

Today, Sri Lanka has an ageing refinery that more often than not, is a huge drain on the Treasury and an idle tank farm but no petrochemicals or oil trading industry.

Sri Lanka regards the oil tanks as a national asset and guards them jealously but lacks the know-how and technology to exploit them. The government of Singapore had no expertise in oil refining, oil trading or petrochemicals either but they allowed private companies that had the know-how to operate unmolested. 
Even by today’s standards, the total capacity of the tanks in Trincomalee is a respectable size. In 1957, this was massive, the basic infrastructure for oil trading but left unused, they were worthless. 

This obsession with ownership has percolated from political leaders to the public. Amidst howls of protest, the Indian Oil Company was permitted to use 14 tanks but attempts to attract investors to develop the rest of the field have fizzled out in the face of opposition, so they remain unused, rotting in the jungle, a curiosity for tourists.
Michael Porter observed that “productivity is the goal, not whether firms operating in the country are domestic or foreign owned. What matters most is not ownership but the nature and productivity of the companies’ activities in a particular country”.

The first oil refinery in Singapore was built in 1961, by Shell, the same year in which Shell and other foreign oil companies were booted out from Ceylon. Today, Shell’s largest wholly-owned refinery in the world is in Singapore. It also runs a major petrochemical production and export centre from Singapore. Shell is not the sole investor in Singapore’s oil sector either; many international oil companies have refining and distribution interests in Singapore.
Allowing multinationals to own assets in Singapore does not appear to have been detrimental to the public good.
Unfortunately, foreign investment in this country is demonised; politicians, who risk proposing it, are accused of being in the pay of foreign powers, selling national assets, priceless resources that must be preserved for generations. The attitude is similar to that of miser who buries treasure in the ground. The experience of the oil tanks typifies this attitude. Left idle, they bring no benefit, except to the thieves who have removed some components.

This attitude ignores entirely the benefits that arise when assets are utilised. Foreign companies may own assets but they contribute to the local economy directly through employment and productivity effects (as national output rises when previously idle assets are put to use) but also indirectly through transfers of knowledge, technology and innovation.

The transfer of know-how and technology upgrades the potential for the sector involved and for the economy as a whole. This can then extend further from the foreign company to linked firms-suppliers and local customers that are known as spillovers. This is what transformed Singapore into one of Asia’s main energy and petrochemical hubs and one of the world’s top three oil trading and 
refining centres.

A similar effect was seen when Suzuki invested in a car plant in India in the 1980s. Suzuki made a significant investment in improving the organisational capabilities of the Indian component producers to meet the domestic content requirements to manufacture their cars. The result was a remarkable transformation of the competitiveness of the Indian automobile sector based on a significant transfer of technological and organisational capabilities.
In the 1990s, DaimlerChrysler, Fiat, Ford, GM, Honda, Hyundai, Toyota and others followed Suzuki in similar deals. By the end of the 1990s, the Indian component manufacturers were winning Japanese awards for quality.

If living standards are to improve, then resources must be exploited. Foreigners can bring in scarce capital, technology and know-how.

Foreign investors will only come if there is confidence, which is something that results from predictability – in policies, in actions. These in turn grow from rules-based systems. Respect the right to private property and uphold the rule of law. When decisions are based on clear rules, evenly enforced, it creates consistency. A state based on institutions and systems as opposed to one based on personalities is an attractive one for business. 

The attitude of a dog-in-the manger, sitting on assets but unable to use them, will take us nowhere.

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