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January 30, 2019

Refineries deserve better treatment, adequate protection

Business

January 30, 2019

Pakistan’s oil sector has been booming; demand for crude oil, gasoline and diesel, has been growing and projected to continue to grow at 10 percent per annum for the next five years (OCAC, 2018). Refineries play a major role in our energy needs. They save Pakistan billions in foreign exchange annually, give jobs to tens of thousands, contributing heavily to the national exchequer in duties and taxes while strengthening Pakistan’s energy security.

However, the refining industry has received little support from the government in the last decade and is often at the receiving end of undue criticism, including from former policy planners. This shakes the confidence of the sector’s participants, who have already invested billions in the country, and could impede the energy industry’s growth.

For instance, some critics of the energy industry have claimed that the sector needs government subsidies to survive and the state shouldn’t strive for investments in oil refineries. This is misleading and incorrect:

Pakistan’s refineries do not get direct subsidies or heavy payouts from the government for their survival. Many industries receive some form of government support; fertilisers benefit from gas subsidies, automotives receive tariffs on vehicle imports, and banks get heavy government borrowings and low deposit mark-up rates.

Oil refineries, however, receive minimal support in the form of 7.5 percent of duty on high-speed diesel, but since a refinery produces a number of other fuels as well, the net impact is just 2.25 percent on the whole barrel. This modest tariff protection for a heavily capital intensive industry, which imports its raw materials is simply inadequate.

Petroleum business model is fairly straightforward and usually profitable, although margins are underpinned by movements in oil prices. The oil and gas production sector earns profits by extracting and selling hydrocarbons.

Refineries make profits processing and converting crude oil into various refined products which are sold to oil marketing companies and other buyers. They also feed petrochemical and other ancillary industries.

In Pakistan, unlike the power and food sectors for whom significant subsidies are allotted in the annual budget, the oil refining sector doesn’t receive any special treatment. On the contrary, its participants pay hundreds of billions of rupees each year in taxes and duties. In FY18, four leading listed refineries contributed Rs176.9 billion to the exchequer as taxes, levies, and duties. Pakistan’s leading refineries have shown that they can turn decent profits even in tough times. The refiners typically thrive in a weak oil price environment, since they use crude oil as a raw material and any reduction in international oil prices lowers their cost of production. But they can report losses when oil jumps higher.

For refiners in Pakistan, the third quarter of this calendar year was a difficult period with the price of the international benchmark Brent crude climbing to $80 a barrel by late-September and its negative impact was compounded by the rupee’s devaluation. But some of the biggest refiners still managed to post a profit.

Secondly, it should be remembered that in a free market economy, the state should not dictate which public investments would be allowed. The governments might encourage investments in certain sectors for strategic reasons, but ultimately market forces should determine which industries were the most profitable and economically viable. For market forces, especially foreign investors, the message is loud and clear – Pakistan needs more refineries.

Foreign investors want to set up oil refineries in Pakistan. Following Prime Minister Imran Khan’s recent visit to Saudi Arabia, the Kingdom has agreed in principle to set up an oil refinery near Gwadar. A Chinese company has reportedly shown interest in developing an upcountry deep conversion oil refinery. PARCO, which is a joint venture between the government of Pakistan and the Emirate of Abu Dhabi, is already working to develop a deep conversion refinery at Hub near Karachi. Global investors are eager to invest billions in Pakistan’s oil refining space which is a testament to the fact that this industry promises solid returns on investment over the long run.

Another misconception about refining is that it doesn’t create significant foreign currency savings for Pakistan. In reality, Pakistan saves billions of rupees every year by importing cheaper crude oil and refining it at home, instead of importing expensive refined products like petrol and diesel.

The combined capacity of five Pakistani refiners – ARL, Byco, PARCO, NRL, and PRL – is close to 420,000 barrels per day. Even if these refiners create savings of just $0.75/barrel and utilise 70 percent of capacity, then they will still create foreign currency savings of $80 million each year, or around Rs11 billion at the ongoing exchange rate of Rs137/$. Note that these are fairly conservative estimates and the actual positive impact of the entire refining industry on Pakistan’s foreign exchange reserves was likely to be considerably larger. People claim refining doesn’t create many jobs. The truth is that each refinery typically employs 3,500 people, including highly-skilled, semi-skilled and non-skilled people directly involved in the refinery operations. Refineries also create a number of indirect jobs by utilising the services of a variety of market and non-market actors, such as private contractors who provide transportation services. Therefore, Pakistan’s refineries utilise tens of thousands of direct and indirect employees.

Refineries are wrongly criticised for running antiquated facilities. False! PARCO has built one of the most modern refineries in the world near Multan. NRL’s plants were built in the 1970s, but since revamped and upgraded its facilities. ARL overhauled in 2016. Byco Petroleum installed equipment which was previously operating in the west, but its facilities are still younger than most other players in the industry. Although occasionally production may get disrupted, as in any other chemical process based facility, by and large refineries run smoothly and dependably.

Pakistan’s energy industry and oil refining sector are the backbone of the country’s economy and deserve better treatment and adequate protection from the government.

The writer is an oil industry professional

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