The circular debt is a menace that consecutive governments have unsuccessfully tried to eliminate. Numbers are terrifying: the last government cleared the circular debt amounting to Rs480 billion immediately after coming to power in June 2013.
But it has now increased to more than Rs1 trillion, including the amount parked with the power holding companies. This is besides the subsidies amounting to more than Rs1.2tr that the power sector received in the last five years. Nonetheless, service delivery despite huge bailouts remains far from excellent as load-shedding is still a permanent feature of our power sector.
What has gone wrong? Some suggested solutions call for improving the governance system in the power sector by limiting line losses and increasing recoveries. Others suggest that the performance of top management be measured against key performance indicators (KPIs). Also, there have been suggestions about outright privatisation and divestment of the government’s shareholding to get rid of loss-making companies.
The government should be concerned about the sustained erosion of PSO’s competitive advantage, which can lead to dire consequences in the long run
However, there is an overlooked solution that can immediately stop the build-up of circular debt. It lies in strengthening the corporate governance structure of Pakistan State Oil (PSO). The oil marketing company looks like an entity that is already privatised with the government’s shareholding of only 22.47 per cent.
However, the devil’s in the detail. PSO is governed under Marketing of Petroleum Products (Federal Control) Act 1974. It defines PSO as a marketing company, which is always subject to government control. Sections 6 and 7 of the Act empower the government to appoint managing director and members of the board of management instead of an independent board of directors that could subsequently install management of its choice.
Furthermore, Section 11 prevents members of the board from refusing to adopt the balance sheet of the company with powers mainly concentrated in the hands of managing director. The board of management is also appointed by the government that “shall hold office during the pleasure of the federal government on such terms and conditions as it may determine” instead of a robust and technical criterion suited for an oil marketing and a logistics company.
Why does the government want PSO under its control? One, there is a legitimate strategic consideration at play. This means having a national oil marketing company on hand in a crisis or emergency situation. Two, and more importantly, PSO bails out the government on a regular basis.
For instance, PSO provides critical fuel supplies to Pakistan International Airlines (PIA) and power generation companies. In PIA’s case, PSO’s receivables are over Rs15bn. It is well known that PIA is already in dire straits and does not have the capacity to pay for expensive jet fuel.
In the power sector, generators do not have adequate cash to procure fuel supplies as they don’t receive funds from government agencies in time. As a result, PSO’s receivables have crossed Rs300bn.
Despite maintaining an overall market share of 55pc, PSO’s market share in critical areas has come down steeply. In petrol, its market share came down from 51pc in 2012-13 to 40pc in 2016-17. The reduction is even steeper in diesel: from 57pc to 44pc.
An ordinary PSO shareholder should be concerned about the company’s performance in two major fuel segments despite the fact that it has nationwide logistics and supply chain infrastructure. The government should be even more concerned about the sustained erosion of PSO’s competitive advantage, which could lead to dire operational consequences in the long run.
If the government decides to repeal Marketing of Petroleum Products (Federal Control) Act 1974, a private-sector party will immediately take control of the board. It will consequently appoint suitable candidates to all important positions. This will improve investment decisions and long-term business performance as the new team will invest in improving logistics, storage, terminals and infrastructure instead of holding up cash for sub-optimal purposes.
Furthermore, PSO will not supply fuel without adequate payment assurances. There might be an adverse situation leading to temporary breakdowns in PIA and power generation entities, but the long-term benefits will be immense. For instance, the flow of the circular debt will stop immediately. Newly strengthened PSO will want greater payment assurances from all players. Knowing that there will be no further bailouts, there will be greater accountability on the part of the government to fix governance structures. The road to that path will be tough initially, but it will make officers at the helm of affairs more accountable and responsible.
But what about strategic considerations? There are legitimate concerns that after PSO’s corporatisation, supplies to PSO and power companies will be disrupted if payments are not made in the case of emergency and war-like situations.
Two mechanisms could be put in place. One, a surcharge can be levied on petroleum, oil and lubricants’ retail sales to ensure that the country’s strategic reserves are always maintained. Two, the government can provide oil marketing companies with counter-guarantees on behalf of strategic customers that will ensure continuous supplies in emergency-like situations. Such an arrangement is already in place with K-Electric for its strategic customers.
Strengthening corporate governance is high on the new government’s agenda. It should start with PSO. The path will initially be murky, but it will pave the way for a more robust, financially viable and operationally strong oil marketing company of the future.
More importantly, it will put pressure on stakeholders to get their house in order instead of relying on another company for repeated bailouts. Furthermore, it will stop the flow of the circular debt once and for all, thus ensuring an efficient and optimal use of resources.
The writer is an energy policy consultant
Published in Dawn, The Business and Finance Weekly, September 3rd, 2018