Liberalization of Fuel Prices

On May 19, 2020 the President of Ecuador issued Executive Decree 1054 amending the Executive Decree 338 – Regulation of Prices for Hydrocarbon Derivatives. This liberalizes fuel prices, which are calculated monthly and considering the Oriente and WTI marker crudes. The amendment applies to super, extra and extra-ethanol gasoline; diesel 2 and premium diesel for the automobile segment; extra and extra-ethanol for the ‘other fisheries’ segment; and  diesel 2 and premium diesel for the shrimp, tuna and other fisheries segment.[1]

The liberalization of fuel prices implies a departure from the existing model for the above fuels. With the exception of super gasoline which had a system of monthly prices set by Petroecuador, extra and extra-ethanol gasoline, diesel 2 and premium diesel had fixed selling prices at the terminals and depots and a fixed margin for commercialization. This was based on article 72 of the Hydrocarbons Law which enables the President of Ecuador to regulate the selling prices of hydrocarbon derivates to the consumer. In this instance and in use of his power, the President has changed this fixed price model to a new one which will vary each month, considering a series of critera, as follows.

How are fuel prices liberalized by the reform?

• Instead of fixed prices, the prices will change monthly using a system of bands, with monthly variation limited to +/-5% (USD/gallon) at terminals and/or depots at the supplier level.
• Initial prices for the supplier will be:
  • Extra and extra-ethanol: USD 1.409821; and
  • Diesel 2 and premium diesel: USD 0.770535.
• These initial amounts may vary monthly by a maximum of +/-5% depending on whether the selling price of fuel at the terminal for the period prior to the period of analysis is more or less than the value to cover production costs in the period of analysis. If the variation is more than 5%, the state would have to subsidize the difference.
• The margin for the supplier will be positive when the production costs in a period of analysis are less than the selling price at the terminal in the same period.
• The selling margins are fixed at the following values: extra and extra-ethanol gasoline (including VAT): USD 0.171; and diesel 2 and premium diesel (including VAT): USD 0.137.
• The retail price[2] at the pump level for the initial period is initially fixed at: extra and extra-ethanol gasoline (with VAT) automobile segment: USD 1.75; and diesel 2 and premium diesel (with VAT): USD 1.00. The method of calculating the price of super gasoline does not change.
• The price at the supplier level of super gasoline cannot be equal to or less than that of extra and extra-ethanol gasoline.
• This system will be implemented from July 1, 2020.

What are the consequences of this reform?

• Opportunities for companies engaged in the import of derivatives and construction of storage systems for hydrocarbon derivatives. Currently, the Hydrocarbons Law permits the import of derivatives and the construction of storage systems, but these have not attracted investment due to the regulated price system. By liberalizing prices (under a band system), it is hoped to attract private investment to compete in the construction of storage systems and derivative imports on equal terms with PETROECUADOR.
• Lease of Petroecuador infrastructure. Another issue faced by private importers of derivatives was a lack of storage capacity for their products. Since this Executive Decree came into effect, the authorities have said that Petroecuador will lease and make its storage infrastructure available to third parties at competitive rates to be set by the authority.

What still needs to be defined?

• Set-off systems. The 4th general provision of the Executive Decree states that the Ministry of the Economy and Finance and the Ministry of Energy and Non-Renewable Natural Resources will design public policies for set-offs as a result of the liberalization of prices. It could be understood that this set-off system will be for specific segments who may be affected by price increases, especially the most vulnerable sectors of the economy.
• Operation of the band system. Although this system is considering current market conditions with low oil prices and no expectations of sudden increases, the applicability of a +/-5% limit remains to be seen when there are conditions which cause oil prices to shoot up or plummet in the short-term. The state must act as events develop.
• Import and storage of derivatives. If there is interest from private parties to import fuel or build storage and distribution infrastructure, the existing regualtions must be updated in a practical and effective way which can adapt to the new reality.
• Secondary legislation: The sector authorities have stated that this Decree is subject to  the perfectioning and issuance of the secondary legislation required for its effective implementation.

[1] The Executive Decree clarifies that the following products are not included in this amendment: LPG for domestic use, for public transport vehicles by legally organized taxi drivers and for use in drying agricultural products (corn, rice, soya).

[2] Retail Price= Terminal price plus VAT plus the profit margin plus VAT.