Understanding the Role of Stock Inventories in Oil Pricing

The Press Release below was issued on March 4, 2011 by Pilipinas Shell Petroleum Corp. in an effort to address questions raised about why prices are increasing based on global oil prices when they still have inventory of crude bought at a lower price.

To summarize the article below the answers are:
1. To ensure price transparency - it is the norm in open markets in other countries as well
2. In response to market competition (i.e. refiners vs importers)

In addition, crude is bought on a continuous basis, and so while the crude bought at a lower price 3 months ago is being sold at a higher price now, say a month from now when the oil prices go down, the crude bought at a higher price today will then be sold at a loss by the oil companies.

Anyway, onto the article. It explains it in more details. I encourage you to remove your bias for a second and try to read objectively and understand...

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Understanding the Role of Stock Inventories in Oil Pricing

First Published 04-March-2011

In today’s environment of increasing prices of crude and petroleum products, a common question being raised is ‘why are local selling prices reflecting current high prices when oil companies have inventories bought some time ago when prices were lower? Shouldn’t they first exhaust their old stocks following "first in-first out" accounting and not have windfall gains at the expense of the public?

This question appears logical and reasonable at first glance. But it is worth understanding that countries where markets are open like Singapore, Hongkong, Australia, United States, United Kingdom, France, among others, similarly reflect international oil prices immediately, some on a daily basis like the US and Thailand, and others on a weekly basis like Hongkong and Singapore.
"The main reason for this is to ensure pricing transparency..."
The main reason for this is to ensure pricing transparency, such that what the public sees in the international market, whether prices are going up or down, are immediately reflected in the local market.

To explain further, refiners and finished product importers have different inventory levels, with refiners having about 40-60 days of stocks, while product importers normally maintain about 7-14 days of stocks.

As has been observed in the market, when prices are increasing, which is what is happening now, even if refiners hold a longer term inventory of say, 45 days, if they continue to sell at lower prices till they use up their inventory, this may be seen to be undermining competition.

Conversely, when prices are dropping, product importers will immediately reflect the current lower prices, which refiners are forced to match in order to remain competitive. For how will they make the public accept a delayed price reduction, just because they have stocks bought at high prices? How will the public know what inventory levels and days they should wait before prices are reduced? Will the oil companies not be accused of delaying price reduction to make more money?

For the above reasons, reflecting current international oil prices is the most transparent way of pricing and therefore, the norm in open markets. Currently, the utmost urgency is in ensuring supply security and mitigating the impact of the price increases to the public, especially the disadvantaged sectors.

In support of the Government, we in Pilipinas Shell Petroleum Corporation (PSPC), have increased our crude and product inventories at maximum levels of at least 60 days, to ensure continuity of supply to meet our customers’ requirements, notwithstanding the associated higher costs of doing so.

Further, to mitigate the impact of higher oil prices on the public, we are maintaining close to 150 Shell Pepeng Pasada Club Loyalty and DOE lanes that offer discounts to public utility vehicles. We likewise remain in support of the Government’s advocacy on energy efficiency and conservation.

This is a time to engage and help calm the public, and to plan for contingencies. We continue in our aims of working together towards helping the Philippines address the ever-increasing challenges of our changing world.

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Read this article in Filipino: "Pagpapaliwanag Ukol sa Imbentaryo at Presyo ng Langis"

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