Fuel charge on hot air
Political controversy is fuelling the considerable misapprehension about the fuel surcharge added regularly to water and electricity bills. The surcharge is an inescapable financial reality for consumers. It is also that for Enemalta and the government.
Political controversy is fuelling the considerable misapprehension about the fuel surcharge added regularly to water and electricity bills. The surcharge is an inescapable financial reality for consumers. It is also that for Enemalta and the government. The interaction, however, tends to detach proper understanding from that reality.
The surcharge was the wrong mechanism from the very beginning. Once the idea - a correct one - was to let water and electricity tariffs reflect the real market price of fuel, tariffs should have been introduced to reflect market reality. Social and economic considerations could then be brought to bear to mitigate the tariffs where necessary - but without for one moment hiding the market reality. Only reality can allow consciousness of the true cost of producing water and electricity to develop, allowing for any production inefficiencies, the cost of which the consumer of a monopoly product should not be required to carry.
Apparently the real-price approach could not be implemented, because the billing software used by the Water and Services Corporation was not capable of it. At least, that was what a high political authority told me some years back. It would seem the software was not changed because of the high cost involved.
Instead at a point in time the Investments and IT Ministry gave a detailed explanation which few may have bothered to read and even fewer understood. The explanation set the basis for calculating the surcharge, which should have stuck. It is actually quite simple to follow, until twists and turns are introduced.
The cost of fuel used to produce electricity, which also powers the reserve osmosis plants, depends on the international price of fuel oil, which in turn is linked to the international price of crude oil. Spot and forward markets exist for both commodities. It is usual for large fuel users, such as power stations and airlines, to be active in the forward market, through various measures known as hedging.
One hedges one's bets; one hedges one's risks. Looking at today's price - the spot price - one takes a view of where it might be going and buys forward. One either buys the real thing or a financial derivative. The forward price is set by expectations and interest costs over the covered period.
If the hedge goes in favour of the buyer, one makes a profit, by selling the derivative at a given time and buying the commodity for actual delivery in the spot market. Or, if one has actually bought the commodity for forward delivery, a notional profit occurs when it is delivered, should the spot price be higher. The reverse applies should the spot price drop. This is a crude outline of how covering takes place but it should suffice for basic understanding.
The second factor is the exchange rate of the country's currency against the dollar. In our case, for over two years this has meant the exchange rate between the dollar and the euro, because the lira was 100 per cent linked to the latter. The exchange rate can also be covered forward, roughly according to the same principle as for futures in commodities.
The buying cost of fuel oil and the exchange rate taken together gives the cost in domestic currency. That cost, converted unadorned into water and electricity tariffs, should ideally be made known to the public. Thereby everyone would know the real cost of water and of electricity. The government of the day would then subsidise the real cost according to its social and economic policies in respect of household consumers and business users.
One used to think that this was, broadly, what was going on. I say broadly because the government did not leave it so simple. It made Enemalta bear part of the increase in cost, to compensate for its inefficiencies, and also indicated that it gave an overall subsidy to Enemalta. Following that, privileged social and economic rates were brought into play, leaving the majority of users to bear the remaining cost.
It now turns out that is not what has been happening. The Labour Opposition declared that the fuel surcharge was not correctly worked out and that it would tackle it upon being returned to office. "Tackling" initially meant having it audited and then addressed. Later the impression was given that the surcharge would be removed. Now the position is that a Labour government would halve the surcharge as soon as it is elected.
That commitment keeps coming up in the political debate. The government has counter-fired two bullets. One is a question: Would a Labour government halve the fuel surcharge before subsidies are taken into account, or after? The second bullet is a claim that the government is already halving the surcharge from what it should be if the full cost of fuel oil was taken into account.
In firing these bullets last week the government came up with various claims and revelations. It claimed that the hedging done over the past six months cut the cost by 2 per cent. Presumably that meant there was a saving relative to current prices higher than the hedged price. It claimed that sale of existing hedges reduced the price by (another) 12.5 per cent. No one said what that meant exactly. Presumably future contracts were closed out at a profit. Whether that was wise or not at a time of rising crude oil prices is another matter which the ministry did not bother going into.
Then came a revelation. Over the past months, the ministry said, fuel oil rose from $311 to $411, the highest price in the past four years. The surcharge at these prices would have been 85 per cent had it covered all the increases, argued the ministry. But the government realised it would be too much of a burden on the economy and decided that most of the increase should be borne by Enemalta and the government.
As an aside one might ask when exactly that took place and whether it artificially cushioned the rise in the cost of living just when Brussels was considering whether Malta qualified for euro adoption. Asides apart, the revelation means that we are at more of a loss than usual to know exactly what the economic tariffs for water and electricity should be.
Such knowledge might inhibit waste. And it might also encourage theft. But the reality should be known to all, all the time.
Unless that is the case no one can begin to tell what exactly the surcharge represents relative to true cost, immaterial of what is put on our water and electricity bills when actual readings are billed. Nor can anyone begin to understand what a political promise to halve the surcharge truly represents in financial terms.
Perhaps if a charge was introduced on political hot air, politicians might speak in clearer terms than they are now doing on this issue.
The surcharge was the wrong mechanism from the very beginning. Once the idea - a correct one - was to let water and electricity tariffs reflect the real market price of fuel, tariffs should have been introduced to reflect market reality. Social and economic considerations could then be brought to bear to mitigate the tariffs where necessary - but without for one moment hiding the market reality. Only reality can allow consciousness of the true cost of producing water and electricity to develop, allowing for any production inefficiencies, the cost of which the consumer of a monopoly product should not be required to carry.
Apparently the real-price approach could not be implemented, because the billing software used by the Water and Services Corporation was not capable of it. At least, that was what a high political authority told me some years back. It would seem the software was not changed because of the high cost involved.
Instead at a point in time the Investments and IT Ministry gave a detailed explanation which few may have bothered to read and even fewer understood. The explanation set the basis for calculating the surcharge, which should have stuck. It is actually quite simple to follow, until twists and turns are introduced.
The cost of fuel used to produce electricity, which also powers the reserve osmosis plants, depends on the international price of fuel oil, which in turn is linked to the international price of crude oil. Spot and forward markets exist for both commodities. It is usual for large fuel users, such as power stations and airlines, to be active in the forward market, through various measures known as hedging.
One hedges one's bets; one hedges one's risks. Looking at today's price - the spot price - one takes a view of where it might be going and buys forward. One either buys the real thing or a financial derivative. The forward price is set by expectations and interest costs over the covered period.
If the hedge goes in favour of the buyer, one makes a profit, by selling the derivative at a given time and buying the commodity for actual delivery in the spot market. Or, if one has actually bought the commodity for forward delivery, a notional profit occurs when it is delivered, should the spot price be higher. The reverse applies should the spot price drop. This is a crude outline of how covering takes place but it should suffice for basic understanding.
The second factor is the exchange rate of the country's currency against the dollar. In our case, for over two years this has meant the exchange rate between the dollar and the euro, because the lira was 100 per cent linked to the latter. The exchange rate can also be covered forward, roughly according to the same principle as for futures in commodities.
The buying cost of fuel oil and the exchange rate taken together gives the cost in domestic currency. That cost, converted unadorned into water and electricity tariffs, should ideally be made known to the public. Thereby everyone would know the real cost of water and of electricity. The government of the day would then subsidise the real cost according to its social and economic policies in respect of household consumers and business users.
One used to think that this was, broadly, what was going on. I say broadly because the government did not leave it so simple. It made Enemalta bear part of the increase in cost, to compensate for its inefficiencies, and also indicated that it gave an overall subsidy to Enemalta. Following that, privileged social and economic rates were brought into play, leaving the majority of users to bear the remaining cost.
It now turns out that is not what has been happening. The Labour Opposition declared that the fuel surcharge was not correctly worked out and that it would tackle it upon being returned to office. "Tackling" initially meant having it audited and then addressed. Later the impression was given that the surcharge would be removed. Now the position is that a Labour government would halve the surcharge as soon as it is elected.
That commitment keeps coming up in the political debate. The government has counter-fired two bullets. One is a question: Would a Labour government halve the fuel surcharge before subsidies are taken into account, or after? The second bullet is a claim that the government is already halving the surcharge from what it should be if the full cost of fuel oil was taken into account.
In firing these bullets last week the government came up with various claims and revelations. It claimed that the hedging done over the past six months cut the cost by 2 per cent. Presumably that meant there was a saving relative to current prices higher than the hedged price. It claimed that sale of existing hedges reduced the price by (another) 12.5 per cent. No one said what that meant exactly. Presumably future contracts were closed out at a profit. Whether that was wise or not at a time of rising crude oil prices is another matter which the ministry did not bother going into.
Then came a revelation. Over the past months, the ministry said, fuel oil rose from $311 to $411, the highest price in the past four years. The surcharge at these prices would have been 85 per cent had it covered all the increases, argued the ministry. But the government realised it would be too much of a burden on the economy and decided that most of the increase should be borne by Enemalta and the government.
As an aside one might ask when exactly that took place and whether it artificially cushioned the rise in the cost of living just when Brussels was considering whether Malta qualified for euro adoption. Asides apart, the revelation means that we are at more of a loss than usual to know exactly what the economic tariffs for water and electricity should be.
Such knowledge might inhibit waste. And it might also encourage theft. But the reality should be known to all, all the time.
Unless that is the case no one can begin to tell what exactly the surcharge represents relative to true cost, immaterial of what is put on our water and electricity bills when actual readings are billed. Nor can anyone begin to understand what a political promise to halve the surcharge truly represents in financial terms.
Perhaps if a charge was introduced on political hot air, politicians might speak in clearer terms than they are now doing on this issue.