Since 2018, the oil industry is going through extremely challenging situation. There are four major adverse drivers that pushed the oil industry to the verge of collapse. Let us try to understand and analyse rationally the challenges/issues oil industry is facing and due to which huge financial losses incurred particularly during the last three years.
Oil industry is a heavily regulated; both Oil and Gas Authority (OGRA) and Ministry of Energy and Petroleum (MEPD) have a strong control on it. OGRA being the primary regulator of the midstream and the downstream industry, watching the strategic and critical aspect of the Oil & Gas sector. OGRA also monitors the petroleum products and prices, the prices are determined based on the previous month’s Pakistan State Oil (PSO) cargos, recommended by OGRA and approves by the Prime Minister. While MEPD on a monthly basis and as and when required by the ministry manages, controls and approves supply/demand planning, determination of shortfall and import quantities, allowance of the permission or otherwise to import and quantity, allocation of local refineries production, and approval of timing of imports.
In the entire business model, among the stakeholders, the oil industry earns the least margin that too regulated by the government (refineries based on the crude oil average monthly prices vs the PSO cargo prices, which sometime go negative and vice versa). For example, in case of Oil Marketing Companies (OMCs), the regulated margin is Rs2.81/liter which is less than 4 percent of the total price. The dealer margin on petrol is Rs3.70/liter and on High Speed Diesel (HSD) it is Rs3.12/liter. The government earns a total of Rs41.78/liter [on petrol) (56.1 percent of total price) and Rs45.26/liter [on HSD] (56.5 percent of total price) because of the Petroleum Levy (Rs30/liter), Sales Tax (approx Rs11/liter) and custom duties (to a maximum of Rs3.61/liter) . Over the last three years, the margin has only adjusted upward for inflation. For instance, last year it was only Rs0.17/liter adjusted in November 2019. During this time, OGRA, enforced a number of investment-intensive requirements including maintaining 20 days inventory in storages, asking OMCs to build own oil terminals across the country and a keeping a compliant fleet with increased standards upgradation.
OMCs have to import more than 70 percent of petrol and over 40 percent of HSD. Likewise, a considerable volume of crude is also imported by the refineries. During 2018 and 2019, the industry lost over Rs40 billion, due to an aggregate rupee depreciation of over Rs50, which is 56 percent. On January 1, 2018 it was Rs105 and now it is around Rs164 to a dollar). In 2020, further depreciation of Rs9 (Rs155 vs Rs164, the prevailing rates) contributed further increase in the said amount.
In April 2020, the mechanism to absorb the exchange loss or gain in the prices was approved by the government. However, by that time the industry had already lost an estimated Rs50 billion.
The other factor contributing in oil industry’s financial woes is the turnover tax, which is applicable on the “gross receipt basis” instead of the “regulated margins” (which is the actual revenue of the industry). The regulated margins constitute less than 4 percent of the total regulated price; however, the turnover tax is applicable on the total price. Also, in the last budget, the turnover tax was increased from 0.5 percent to 0.75 percent.
During COVID-19, the government extended relief to a number of industries including construction etc. In addition, State Bank of Pakistan has also offered relief to the banks and its customers. However, in case of the oil industry, no relief was provided, instead the oil industry had to bear sizeable inventory losses due to unprecedented price decline in the global markets (Rs42/liter and Rs37/liter on petrol and HSD from March until May, respectively). During this period, oil refineries alone lost Rs31 billion due to inventory losses and an estimated more or less the same amount lost by OMCs.
A number of companies in the oil industry either have already witnessed erosion of their shareholder equities fully or will meet the same fate in the near future. Practically speaking most of the companies are running businesses on borrowed funds.
Additional expected loss, during June due to price gap between local ex-refinery and global prices will completely annihilate their operation resulting in huge adverse impact to the country and the public at large including the potential unemployment. The potential downfall of the oil sector will also cause substantial losses to tax collection as the oil price has more than 50 percent element of taxes/duties, which Oil Industry is collecting on behalf of the government and depositing into the government treasury.
Analyzing the current situation on Shortage of Fuel:
On March 23, the government announced lockdown across Pakistan in order to control the spread of COVID19 Pandemic. Subsequently on March 25th MEPD imposed ban on import, and also directed the companies to cancel the planned imports. Due to the closure of border there was no influx of smuggled products in the market, coupled with harvesting season, the demand of products surged. Despite lockdown, during full month of April 2020, the petrol sales declined by 20 percent, whereas the sales of HSD heavily increased by 42 percent. With such level of demand, the country stocks unexpectedly depleted rapidly. The ministry gave the permission to import on April 28, though by that time it became extremely challenging to bring imported cargos due to non-availability of vessels and higher premiums. During the COVID-19 crises, the ministry was doing weekly import planning, which is impractical to manage as international product market and vessel availability requires 30-45 days’ planning.
On top of it, the last month prices were changed further downward by Rs7 based on the PSO cargos, booked in April, thus increasing the price delta by Rs20/liter between the local ex-refinery price and global price. Due to this huge price differential the local refineries also could not afford to import crude resulting in shortage of the product from local refineries as well.
Although, the government is taking the plea that they are keeping the PMG/HSD available through PSO but are neglecting the fact that PSO has planned limited imports on the current prevailing local prices and if they keep on supplying, they have to use their high price imported stocks, which will result in huge loss to the national company
It is also a normal market practice that the dealers during months when a downward change in prices in expected withhold upliftment of product to avoid stock losses, keeping the bare minimum stocks. This contributes unnecessary load on the logistics on the first few days of month following the price change and create artificial dryout situation around the retail network across the country.
The government should step in and revise the prices for the month of June based on the recent PSO cargos to bring the prices in line with global prices by reducing the Petroleum Levy which is standing at Rs30/liter for both petrol and diesel. This will ensure the shortage of fuel supply is addressed in June.
A short-term solution is both petrol and diesel pricing formula be changed and linked to Platt’s Oilgram of previous period (last 15 days or 7 days as the case may be) plus PSO import’s premiums and incidentals etc. in the first phase.
Another suggestion is import planning cycle be made of three months with firm imports of petroleum products by OMCs, approved two months in advance rather than the ad hoc periodic approvals as was experienced by the Industry in April and May 2020, which also soured importing companies’ relationships with their international suppliers posing difficulties in obtaining fresh Imports.
Recommendations of the working group of refineries for sustainable operations should also be immediately implemented being measures to mitigate the continuing existential crisis for refiners.
On the other hand, a mid-term solution is that petrol and diesel be completely deregulated including OMCs Margins as soon as it is feasible.
The writer is an industry analyst