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June 12, 2019

LNG vs furnace oil: what to do?


June 12, 2019

LNG has come to stay and there has been an increase its market share due to falling local gas supplies and lack of new significant discoveries. Furnace oil has not gone away, despite its many disadvantages. There is a transition going on; what are the issues and challenges in this transition and how do we manage this transition is something we discuss in the following.

LNG was introduced in the country for the following three reasons: It is cheaper than furnace oil by 20 percent on average; it offers more efficient electricity production by way of combined cycle power plants of 60 percent efficiency vs 38-40 percent of the Furnace Oil Power Plants (FOPP); local gas supplies are falling; gas is environmentally cleaner than furnace oil (the latter has 3.8 percent Sulfur). There were controversies earlier which have gradually died down and a relative consensus has emerged in favour of LNG, although there are provincial issues that we will discuss later.

Some eight million tonnes of furnace oil used to be consumed in the past years producing more than 31 percent electricity by an installed electrical capacity of 8000 MW, including IPPs and public-sector GENCOs. Local production of furnace oil out of refineries stood and continues to be there at three million tonnes per year and the rest was imported; now there are no more imports. The policy is that no more electricity will be produced using furnace oil. In last April, only 4.95 percent of electricity was produced on locally produced furnace oil due to various reasons against policy intent. Local refineries have been asked to export their furnace oil output. They cannot stop producing furnace oil as it is a co-product of highly-needed gasoline and diesel. Reportedly, no step has been taken by the oil refineries towards exports as it would fetch them lower prices in the international market. They are producing and storing in power plants, probably under an informal arrangement. The time is approaching fast when all the storage will be filled and oil refineries will have to stop production – including that of gasoline and diesel – and thus the government of Pakistan will be forced to resume lifting furnace oil again, reversing the policy of no more furnace oil.

What are the problems and options of oil refineries? Most of the refineries are old and outdated. Only two refineries are relatively new, but even they have outdated technology. Most refineries these days utilize catalytic reforming, converting heavier products into a lighter one like gasoline. It would require considerable time (five years) and an investment of around $500 million to be able to add facilities to stop producing furnace oil and produce gasoline and petrol instead.

Would it be wise and feasible for the older refineries to add new facilities? Maybe the newer and larger ones may be in this position, indicating the need for a differentiated policy, which we will explore later. Furnace oil is on its way out in the world. From the power sector, it is already out more or less. It is, these days, being used as a bunker oil by the shipping industry. The International Marine Organization (IMO) has issued a notice to the shipping industry to stop using furnace oil or install scrubbers. This will create a downward pressure on the international prices of furnace oil. This should be a good enough reason for our refineries to adopt conversion and make the investment. However, the status quo may be better for them as they are clinging to the option to be able to continue to offload their product into the local market.

However, LNG is facing some difficulties as well. There are transmission bottlenecks. In addition to the existing infrastructure, a South-North dedicated transmission line was to be installed which hitherto could not be initiated for a variety of reasons. There are technical issues as well. LNG supply comes in spurts and a whole ship has to be unloaded in two days, creating an absorption problem, and the gas is to be diverted to all kinds of efficient and inefficient plants disturbing the merit order. There are no storage facilities. Previously, there was no problem of this sort with the local natural gas whose supplies could be adjusted along with the demand. There is opposition from provinces which want to consume cheaper local gas and are not prepared to pay the higher cost of LNG or even the formula of the WACOG (Weighted Average Cost of Gas). The Punjab-based textile industry opposes different prices of gas, as they are given LNG at higher LNG prices. Some provinces (Sindh and Khyber Pakhtunkhwa) also want to install NGCC (combined cycle power plants) to consume local gas.

There is capacity surplus in the power sector. It has been predicted that a surplus of 20 percent will remain for a long time which will increase the fixed capacity charge to 66 percent, pushing up the cost of production and electricity tariff thereof. There are increasing numbers of proposals coming from the Furnace Oil Power Plants (FOPP) of the IPP sector to extend their Power Purchase Agreements (PPAs). These proposals argue that their plants are in perfectly good operating condition. With debt and equity paid off, these should be free except for the fuel cost. However, the tariff reduction that is being offered in some cases is not significant due to the old disease of capital padding in the proposed new investments for refurbishment.

The continuation of the FOPPs provides synergy to the refineries' wish of continuing with the production of furnace oil – a powerful coalition which may be difficult to oppose by the bureaucracy. There are other palliatives as well; converting the FOPPs to coal. One would be inclined to consider the option of utilizing Thar coal. But if they have their way, they would like to use the imported coal – and they have proposed it.

The reasons behind the interest in imports are dubious at best. There are other interesting options like Peaking Power Plants. Some of the FOPPs with Internal Combustion Engines (ICE) can be retained as peakers, operating only a few hours under peak demand. A higher tariff can be afforded as is usual practice worldwide. There are proposals of incorporating the FOPPs in the upcoming power market. The question is: who is the owner under BOOT or should these plants be auctioned to the new owners? Should these plants be converted to gas? The power market is too uncertain despite pronouncements. In India, the market share of power exchanges does not exceed one to two percent.

There are too many constraints and choices to be considered and evaluated by policymakers, indicating the need of a thorough study. Bureaucratic fiat will not be enough if optimal decisions are to be taken maximizing public and larger interest. A negotiation with oil refineries for lifting furnace oil at 20 percent discount may create some flexibility and opportunities for movement in this respect. A 20 percent reduction would be equal to the LNG price. This would mean selling furnace oil at LNG price. International furnace oil prices are projected to fall along these lines as well. Some refineries may then like to export and some may settle for the reduced price. The volume of the problem will be reduced.

It is important to initiate purposeful negotiations at an earlier opportunity than to succumb under the emergency situation of refinery closures which can create a confrontational situation that we cannot afford in these difficult circumstances.

The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy

Issues: Success and Challenges’.

Email: [email protected]

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