Supra profits need supra taxes

It’s been the season for earthquakes. First Mozambique and much of Southern Africa was hit by an uncharacteristic once-in-100-years event.

Then there has been the seismic activity around fuel and petrochemical giant Sasol, which saw R25-billion wiped off its market capitalisation in a five-day period.

The seismic events were the Competition Tribunal’s decision to refuse Sasol’s merger of its liquid fuels business with Engen, denying Sasol an easy entry into the retail market, and Minister of Finance Trevor Manuel’s announcement of an investigation into a windfall tax on Sasol.

The tribunal’s decision followed Manuel’s announcement by a week, but the sharp fall in share price suggests there was a lot of bad news in the market, which may also have had wind of the tribunal’s decision.

It may appear that the government has it in for Sasol, but these developments are just part of a wider push by the government to drive competitiveness in the economy.

Speech after speech by President Thabo Mbeki and key ministers has stressed that the government intends raising the competitive temperature in the country by tackling companies that abuse their market position, such as through monopoly, cartel or import-parity pricing.

The government has included dominant companies in its sights as part of a drive to raise levels of growth from greater levels of efficiency and providing more competitive prices into the economy.

Sasol is vulnerable to this attack on several fronts. The tribunal, for instance, tells us that the basic fuel price (BFP), which underpins the entire industry, is actually set at more than 5% above true import parity, even though industry apologists continue to tell us hand over heart that price regulation is meant to provide prices at import parity.

Think of this difference as an additional 15c a litre each time you fill up.

Sasol benefits from several layers of protection, akin, in the tribunal’s analysis, to being securely inside a ringed fenced.

There would be some economic consolation from this protection if Sasol made its chemicals available to the manufacturing industry at competitive prices. But it reportedly charges the industry 25% more than world prices, ensuring that its share price looks good on the JSE, but limits export and employment growth.

Sasol is not alone in this. In too many cases dominant South African companies have found ways to ensure handsome profits to the cost of the wider economy.

In October the Mail & Guardian compared Sasol’s profits with that of Fortune 500 oil companies. Its 13,8% after-tax profit as a percentage of sales was nearly twice the median 7,4% earned by its 32 peers, including BP (5%), Exxon Mobil (9%), Royal/Dutch Shell (7%), Total (8%) and Chevron (9%).

Top of this profit list, with operating profits of 26% as a percentage of turnover, is Malaysia’s Petronas, the 90%-owner of Engen, Sasol’s partner in proposed fuel giant Uhambo.

Sasol’s South African operations are not far behind, showing 23c in profit for every R1 in sales.

But to understand its true profit driver you have to drill down to its synfuel operations where it makes 40c in profit for every R1 of sales, breathtaking for what is usually a low-margin, high-volume business.

Not even Standard Bank (28,8%), which operates in the relatively high-margin financial services arena, matches this level of profitability.

The best way to regulate profit-ability, any number of free marketers will tell you, is to let the market set prices. Let the supermarkets, for instance, enter the fuel retail market.

In countries such as Australia and the United Kingdom, it is the supermarkets that most actively discount fuel and set prices for the rest of the market to follow.

But the idea of Pick ‘n Pay, with the tiniest of margins, tackling Sasol, with the fattest of margins, is laughable in the extreme. There is no way Pick ‘n Pay could justify spending R1-billion to its shareholders to get a share of the (Gauteng) fuel retail market. For Sasol’s R1-billion is just 13% of last year’s synfuel profits.

In the absence of real competition, the regulator has to do the job. This is the person of the Department of Minerals and Energy’s chief director of hydrocarbons, Nhlahla Gumede.

In the past I have been impressed with his grasp of the issues and apparent keenness to bring competition to the market, but he did not fare too well at all when it emerged before the tribunal that BP had written his policy, before Sasol wrote the new version of the policy (and the press statement he issued).

Regulators do not have a hope against the well-resourced Sasols and Telkoms of this world, to name just two. They have more lawyers, more money, more information, more expertise, more spin doctors and more political connections.

Their stratospheric profit levels prop up a chunk of the JSE and, if you appear to move on them, all sorts of apologists — one writer even called for new subsidies for Sasol — emerge to say you are attacking the very basis of the free-enterprise system.

The fact that their activities have, at best, a passing resemblance to free enterprise is by the by.

Some of these companies, which dominate their sectors, built up their positions during apartheid and under conditions of capital flight.

Now we call for foreign investment but not too many foreigners want to compete with these dominant companies. This is one reason for the glacial progress of the second network operator (SNO).

In some cases, foreigners have only been brought in by giving them big chunks of South African companies. In the case of Iscor (now Mittal), for instance, the company’s earnings were used to pay the purchase price.

What does the government do? It needs, with some urgency — based on continuing outbreaks of violence in townships across the country, not to mention the groundswell of support for leader-without-a-cause Jacob Zuma — to make increasing numbers of people the beneficiaries of growth. Cheaper prices are obviously desirable.

Windfall taxes on energy companies have precedent in countries such as the United Kingdom. Oil companies pay such taxes in numerous jurisdictions worldwide.

In Sasol’s case (“Govt’s R6bn gift to Sasol”, September 23 to 29, 2005) there is the additional factor of a well-publicised agreement whereby it received subsidies — R6-billion’s worth — when oil was below $23 a barrel.

Sasol was meant to pay back this money should the oil price go above $28, but the agreement was allowed to lapse in circumstances that are yet to fully explained by either the government or Sasol.

The tribunal’s finding is pro-competition. It means that the energy sector has finally found a regulator prepared to stand up in the interests of the consumer and growth.

The tribunal tells us that the industry is already benefiting from better prices as Sasol has cut prices to win retail-market share.

The Department of Minerals and Energy can now allow these benefits to flow through to the consumer by using the existing archaic system to reference maximum prices.

This means any refiner or retailer can sell more cheaply than the regulated price. It should be allowed to with the single proviso that self-service stations should remain outlawed.

The government sees import-parity pricing, the practice of setting domestic prices based on world market prices plus all shipping and transport costs, as a prime economic evil.

The practice is particularly harmful in South Africa’s case, given its geographic isolation from competitive markets.

But what can the government really do to discourage the practice? Regulating dominant companies is no easy matter. They are the market.

The FBI and others have found the same in dealing with very smart criminals. In famous cases they have found tax evasion an easier charge to sustain than racketeering.

I do not for one moment want to suggest that the companies in question are guilty of criminal activity, but where companies are reporting supra (the tribunal’s term) profits, there is a case for supra taxes.

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