Thursday July 07, 2022

Oil prices and efficient buying

May 28, 2022

The government has increased petroleum prices by Rs30 per litre. The increase is uniform against all products. There was much talk about some subsidy mechanism for the poor (motorcycles and older cars) and the present finance minister spoke in its favour. This has not yet happened. Possibly it may take some time, or it may be in the second round of the increase since the minister has not negated the possibility of further increase.

The increase in petroleum prices has been made uniform. Diesel prices are kept lower universally. That affects economic competitiveness. Diesel is used by public transport and foods transport. Diesel prices should not be increased in the second round, or public transport operators should be compensated in other ways.

The increase evidently is under IMF pressure. No politician would like to increase prices and lose votes and popularity. However, it may be noted that Pakistan’s gasoline prices are really low. Before the increase, Pakistan gasoline prices were $0.774 per litre as opposed to $0.621 per litre in Saudi Arabia and $0.966 in the UAE. Even in Afghanistan, gasoline prices are $0.897. In India, it is $1.452, Bangladesh $1.012, Sri-Lanka $1.036. Despite the lowest prices in comparative terms, Pakistan’s pricing is unaffordable because of the heavy rupee devaluation. There is double jeopardy: international prices are at their highest in history and we face a severe rupee devaluation.

Unique combinations of circumstances have created a very difficult situation for energy supplies in Pakistan. An extraordinarily hot summer, reduced hydropower due to water problems, commodity (including oil and LNG) price hike due largely to the Russia-Ukraine war and delayed consequences of the pandemic have all created a highly unstable and unsustainable commodity market situation. For developing countries, this has created special problems.

International oil prices have almost doubled from $60/bbl to $112/bbl and gas/LNG prices almost tripled or even quadrupled. Pakistan was already suffering under circular debt of Rs2.3 trillion and now it has to pay subsidies on petroleum. In the past, oil used to be a source of revenue. And now subsidies of more than a trillion rupees have to be paid in order to maintain petroleum prices at a constant level. This is clearly unsustainable. Pakistan is suffering under both current account and fiscal deficits. The rupee is going down and the country is moving towards default. Those who used to oppose IMF intervention are now favouring it for obvious reasons.

Two diametrically opposite impacts are expected due to this oil price increase – increase in inflation and increase in poverty; and a possible decrease in oil demand and thus lower imports and lower current account deficit. Oil imports this year are double than last year, almost $20 billion. A 10 per cent decrease in imports would mean a saving of $2 billion. And IMF assistance may be forthcoming which might stabilize the rupee.

Due to lower international prices earlier, there has been a lackadaisical attitude of successive governments to the issue of oil procuring efficiency. It is claimed that Pakistan oil procurement prices have not been sufficiently efficient. Lower buying cost would have a positive impact on local retail prices and obviate or reduce the need for oil price increase. Although PSO is understood to be doing good in the distribution business, improvements can be done in procuring petroleum at lower prices. To be fair, fragmentation of the procurement under the slogan of privatization and competition is also responsible. Payment of high premiums over international prices is a case in point.

It may be noted that furnace oil local prices are high at $900/t excluding GST (PSO), while international prices for Singapore around the same time periods were $550/t. To add importing expenses of 30 per cent, the landed cost of furnace oil becomes 715 USD/t. There is about a 38-40 per cent margin over landed international prices. It may be noted that furnace oil is not regulated. Everybody imports and declares their own prices. IPPs import for themselves in addition to PSO. It may be argued by the local furnace oil importers and sellers that oil products are not always available at market exchange prices. There is a premium, especially in the shortfall periods.

In the case of diesel, there is a continuing long-term contract with Kuwait Petroleum (KP) for supply of diesel under which a modest premium of $2.5/bbl is charged. Current premium from other spot suppliers is $8.02/bbl for gasoline and $11.17/bbl for diesel.

Such premiums destroy the credibility of the international commodity exchange prices. Regulators must look into the bonafides of such high premiums. Long-term contracts on the lines of KP may be considered for gasoline as well. Base-load demand should be under long-term contracts, while variable demand may be under spot arrangements. There may be a variable component in long-term contracts as well. There is a likelihood that this may bring down the gasoline price. Also, the issue of specification variations vs price must be monitored by the regulator. PSO’s inefficiency becomes a benchmark for all other companies. Is the tradition of combined buying to get better prices outdated?

If oil prices continue to remain destructively high, some unconventional ways may have to be explored. There are private-sector parties which claim that they can help bring cheaper oil and gas. There are some market peculiarities wherein oil is available under various terms and modes. Iran has been managing to sell despite sanctions. Russian oil is being sold at varied prices through various parties and trading companies. Perhaps private parties can do the magic they claim?

One has to be careful about the practices of oil suppliers and trading companies and need not be unduly impressed by the respectability due to the size of their operations. One of the leading trading companies has been fined $160 million on the charges of bribing oil SOEs in South America. Another leading company has been barred from operations by Mexico. Both companies operate here in Pakistan as well. In Pakistan, there would be no dearth of willing partners in this respect. Regulators have to keep their eyes open.

There is a controversy regarding cheaper Russian oil and gas. There are two parts of the controversy: one political and the other technical. India has been benefiting from cheaper oil, although there is great US pressure on India opposing it. China buys oil from Iran at 25 per cent less than international prices under a long-term contract. Whether there was a Russian offer to us or not, the possibility of doing so is there. It might be already happening and oil may be redirected by oil trading companies from questionable sources and the windfall being pocketed by the suppliers companies.

Some mechanism may be developed to increase informal imports from Iran by improving road transport, barter and regional markets. Let us try to be a little unconventional. In case of failure with the IMF, this option should definitely be tried. Even otherwise, the US may be flattered through diplomacy into accepting imports from Russia and even Iran. The world is reshaping in the midst of the Ukraine-Russia war. There is international political competition in Pakistan as well which should be utilized more astutely than otherwise.

The writer is a former member of the Energy Planning




    Amna commented a month ago

    Good suggestions, if transparency and effectiveness should be observed

    0 0