Colombia signaling fuel price reform

Colombia's government is opening a politically sensitive process to align domestic fuel prices with the international market.

Under a 2018-22 National Development Plan (PND) recently approved by the congress, a 19pc value-added tax (VAT) on gasoline and diesel would be reduced to 5pc, to "contribute to the design of a fuel pricing policy that is fiscally responsible and coherent with international price fluctuations," technical finance vice minister Luis Alberto Rodriguez told Argus.

The difference in the tax rate would not be passed along to consumers, but rather shifted to the fuel producer, mainly state-controlled Ecopetrol.

"The VAT reduction will be totally offset by higher income for the producer, which will close the gap between the price paid by Colombians at service stations and the fuel price effectively paid to the oil refiners," Rodriguez said. "In this sense, the final consumer price will not change."

The new measure would cut chronic losses in the Fuel Price Stabilization Fund (FEPC) caused by international price volatility and "the discretionary application of the methodology at times of great uncertainty and political tension," he explained.

The fund, which was set up a decade ago to mitigate extreme price swings in the domestic market, has an accumulated deficit of $14 trillion pesos ($4.2bn).

"This measure will allow the national government to revise the fuel price methodology so it reflects market conditions," Rodriguez said. "The VAT cut to 5pc will generate a savings for the FEPC of $2.1 trillion-$3 trillion pesos, which would be higher than the losses in VAT revenue."

According to the mines and energy ministry, a gallon of gasoline in Colombia is about 800 pesos lower than the international price, while the diesel price is lower by 1,600 pesos. Speaking to reporters last week, mines and energy minister Maria Fernanda Suarez said the VAT reduction is meant to alleviate the pressure of higher prices on the local market and phase out the FEPC altogether. "We want to fix this in a structural way," she said.

The mines and energy ministry currently issues reference fuel prices for 13 major cities in Colombia on a monthly basis. The present nationwide average is 9,182/USG for gasoline and 8,674/USG for diesel. Critics say the price calculations are opaque and subject to political interference.

Colombia's fuel prices are subject to a host of taxes and fees beyond the VAT, including a carbon tax, a wholesale VAT, a pipeline tax and a surcharge designed for municipal road-building, among others, on top of costs associated with biofuel additives. Beyond taxes, the fuel price formula should be adjusted from an export-parity basis to import-parity to reflect the current market reality, the head of Colombia's energy planning agency UPME Ricardo Ramirez has told Argus.

In an earnings call with analysts yesterday, Ecopetrol chief executive Felipe Bayon said the company is "waiting for presidential sanction and regulations to see what (the VAT reduction) implies for Ecopetrol's different business segments."

A preliminary analysis suggests it could indirectly hurt the company, which currently pays 19pc VAT on both purchases and sales.

"The implementation of the article could absorb a good part of the benefits of the financing law," said Ecopetrol chief financial officer Jaime Caballero, referring to the tax breaks that Ecopetrol expects to receive under the government's separate fiscal reform package.

On a broader level, the VAT reduction would be complicated to implement partly because of the existing system of VAT-exempt fuel prices in border departments, said Julio Cesar Vera, president of Bogota-based consultancy Valjer Energy and former president of oil engineers' association Acipet. In those areas the government seeks to discourage smuggling from neighboring countries, mainly Venezuela.

Vera warned that the measure is likely to end up in the courts. "This article has defects in substance and process," he told Argus.

Alvaro Younes, president of oil distributors' association Fendispetrol, urged the government to take a comprehensive approach to address the "capricious" manner in which fuel prices are currently set. "There are too many fuel taxes, and they are too high," Younes said. And a potentially higher differential at the border would encourage even more smuggling, he added.

President Ivan Duque is expected to sign the PND into law is mid-June, after which the legislation would be implemented through detailed regulations.