South Africa needs to get out of its petrochemicals cul-de-sac

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Over the past few years South Africa has suffered because of the poor state of its electricity industry. The country has experienced rolling blackouts, huge cost overruns and long delays in the delivery of new power stations. Finally new power stations are beginning to come on stream.

Concerns over power supply have diverted attention from the bigger brothers, transport fuels and base chemicals, which have similar problems. But nothing is being done to address the gaps.

Antiquated regulation of transport fuels is reinforcing apartheid era policy designs in the petroleum and base chemicals industries at considerable cost to consumers and the economy. These challenges could be overcome if South Africa developed a plan to deal with them as it did for electricity.

The oil industry is nearly double the size of the electricity industry with sales of R365bn a year. This is 40% more than the electricity industry. As in many other countries the South African oil industry is dominated by a few global giants like BP, Shell, Engen, Caltex, Total and homegrown company Sasol. On the petrochemicals front Sasol has a monopoly.

A combination of apartheid era interventions and recent court decisions are leaving key parts of the economy in a cul-de-sac and with taxpayers footing the bill. Court rulings have locked in subsidies to inland refineries built at the direction of apartheid planners, and protected high prices for base chemicals flowing from them.

South Africa’s economy is paying dearly. Consumers are paying for the costs of antiquated regulation around transport fuels without the intended benefits. They are also being short changed because of fewer and high-priced petrochemicals.

The history

Because of legacy issues South Africa’s oil refineries are small, ageing and spread across the country. By-products from oil are essential for a strong petrochemicals industry. Having them clustered would be better because it would benefit feedstock aggregation and diversity without prohibitive transport costs.

As a result South Africa has a limited menu of petrochemicals. The industry has some unique synthetic fuels technologies – developed when oil sanctions were imposed on the country – using coal and gas. But these are the country’s only source of petrochemicals. Other countries have a much wider range enabling more value adding opportunities and a lower import bill.

We must retrace our steps to 1971 to unravel the chain of events that has left the country in this parlous situation. At that time, global oil giant, Total, wanted to build an oil refinery near the port of Richards Bay on the east coast of the country. The apartheid regime wanted it built at Sasolburg, 550km from the coast alongside its first synthetic fuel from coal plant. This is where it was trying to establish a refining and petrochemicals hub, partly based on local coal.

Total agreed, provided that the government paid for the cost of piping crude oil from Durban to Sasolburg. The government agreed, but later passed on the cost to motorists through regulated fuel prices. Nearly 50 years later the courts have ruled that this should continue indefinitely. Government then built a key petrochemicals plant nearby.

In parallel, the government reinforced regulations designed to support the local manufacture of transport fuels using generous international pricing formulas and a government supervised cartel. Much of this structure remains in place today.

In the 1970s international pressure on apartheid increased, led by oil sanctions. The apartheid regime responded with a massive intervention, building Sasol’s synthetic fuels plant at Secunda. The cost of this was partly covered by motorists through higher fuel prices.

To support the Secunda project, the government then closed its key petrochemicals factory in Sasolburg. But Secunda was only producing a limited menu of petrochemicals. This legacy is still being felt today.

The decision to close the Sasolburg petrochemicals factory meant that South Africa lacked certain petrochemicals and suffered shortages in others. This is still true today. The effect has been:

  • bigger chemical imports,
  • a lack of chemical factories,
  • a plastics industry starved of the full range of plastic raw materials, and
  • higher prices.

Oil refining factor

On the other side of the petrochemicals coin lies the oil refining industry. It is in a parlous state. South Africa lacks world scale refineries and associated petrochemical factories.

The country has to import 25% of its petrol and diesel. This is despite generous regulation intended to ensure investment in oil refineries. Instead the industry is locked in an impasse with government over investments necessary to produce cleaner fuels. The industry is refusing to invest unless government uses regulation to make motorists gift it the capital to invest. And then, adding insult to injury, it wants a return on that gift.

The government should resist the demand. South African motorists are already not getting value for money.

This is because regulation in effect collects money from motorists and distributes it along the petroleum value chain. The regulated margins, paid to oil companies by motorists for moving fuel from refineries to service stations, have increased faster than inflation over the last 16 years.

If these margins had been held to inflation the country would be saving approximately R32bn per year and in that period the economy would have saved about R253bn.

Regulation has also given service station margins disproportionately high-growth rates. This has resulted in South Africa having too many service stations. Even a new law introduced in 2003 failed to reverse the trend.

The bottom line is that motorists are still paying too much for fuel and the money being raised by regulation is going to the wrong places. It’s paying for unnecessary service stations instead of what is really needed.

What’s needed?

What the country really needs is more refinery capacity that can provide competitively priced transport fuels and feedstocks for petrochemical factories that can produce the missing parts of the menu and compete with Sasol’s petrochemicals monopoly.

How can South Africa escape this cul-de-sac? Could market forces unleashed by price deregulation undo the effects of massive state intervention? Or is a different intervention required?

In 40 years no investments have been made that fundamentally change the industrial structure put in place under apartheid. A national debate informed by good research is needed to help government devise a plan to get the country out of this costly cul-de-sac.

Rod Crompton is a consultant for the Senior Research Fellow Centre for Competition Regulation and Economic Development at the University of Johannesburg. This article was originally published by The Conversation.