FOR those of us who are still on the road despite the lockdown, let’s begin with the good news coming out of the international oil price crash.
The prices of petrol and high-speed diesel in Pakistan are expected to decrease by Rs23-30 per litre for May in case the government decides to maintain the existing tax rates.
It may, however, turn out to be a disappointment for those who expect too much from the historic collapse of the futures contracts for May in the West Texas Intermediate (WTI) or American crude. The June contracts were back in the positive territory.
Pakistan has nothing to do with the WTI. Its oil imports originate from the Middle East where crude prices fluctuate between $22 and $16 per barrel. The imports of crude oil and petroleum products are mostly based on long-term contracts with Kuwait, Saudi Arabia and the United Arab Emirates and are mostly on deferred payments.
The price of imported gas is also linked to the three-month average of Brent. Domestic oil and gas producer prices are also generally linked to Brent. The domestic production of oil and gas does not offer any saving to Pakistan when crude prices fall below $30 a barrel because of the floor-price protection that energy exploration and production companies enjoy under the petroleum policy.
Unlike China, Pakistan does not have surplus dollars to lift cheap oil and build inventories
There have been fewer drillings of exploration and production wells in the country over the past few years. Lower oil prices generally discourage fresh exploration and development activities, thus causing a long-term loss to the economy and increased reliance on imports. Lower crude oil prices are expected to bring down Pakistan’s oil import bill for the current year by about $4 billion from about $14bn last year.
Pakistan’s remittances are estimated by the International Monetary Fund (IMF) and the World Bank to drop by almost $5bn during the current year. More than four million Pakistani workers are currently employed in the Middle East and almost 2.5m of them are in Saudi Arabia alone. These 4m people are a major source of Pakistan’s inflows. They are at the same time feeding an almost equal number of families back home. As the oil-based economies come under pressure in the Gulf region, there can be job losses and the resultant foreign exchange erosion on top of the existing economic pressure in the country.
The challenges are enormous. The world economies are going under. Lockdowns continue to be in place, albeit with some relaxation, in the United States and Europe. The World Health Organisation (WHO) has warned of increased risks in the second round of infections.
These are our major export destinations. Drawn-out economic crises in the United States and Europe will hurt Pakistan’s products. Major export industries are already reporting the loss of export orders and demanding support from the government.
Moreover, Saudi Arabia and the United Arab Emirates are the major sources of Pakistan’s financial strength. The two sources make up around $7-8bn of our total reserves of less than $18bn. Both economies are estimated by the IMF to contract during the current year.
In the first nine months of 2019-20, the oil import bill is already down over 16pc. In March, the import bill for petroleum products and crude oil was down 33pc and 22pc, respectively, on a year-on-year basis, even though the lockdowns became effective in the fourth week.
There are fewer spot purchases of petroleum products by private companies that are relatively cheaper. More than three-fourths of the imports of petroleum products are through Pakistan State Oil (PSO) on long-term supply contracts. Refineries also receive crude oil under long-term contracts.
As if that was not enough, storages of petroleum products and crude oil are already topped up and a majority of refineries are either closed down or running at a negligible rate. Moreover, Pakistan does not have surplus dollars at its disposal like China to lift cheap international stockpiles and build inventories. But then China is also handicapped despite having $3.4 trillion in foreign exchange reserves. It already doubled its stockpiles during the period it quarantined its cities to fight Covid-19.
The oil war among Russia, Saudi Arabia and the United States is unlikely to end anytime soon. On the one hand, Russia and Saudi Arabia have the common enemy in the shape of US shale oil whose producers, financiers, suppliers and refiners are in the midst of a price war.
On the other hand, Russia and Saudi Arabia have to fight each other for market leadership. Russia is already taking over Europe, which used to be Saudi Arabia’s market, through its oil and gas pipelines. Russia is now bolstered by its recent pipeline to Eastern China.
Saudi Arabia has been looking towards the East for its future oil exports. As part of its ambitious Saudi Vision 2030, Riyadh has been working on diversifying routes and destinations to India, China and linking Gwadar with Oman and connecting its industrial city of Jazan with Eritrea’s Massawa region across the Red Sea. It is joined by other Gulf economies in the process to thwart the Russian plan to become the main global supplier of energy.
The low-price environment also provides the government with a life-time opportunity to remove price distortions in the oil industry. Let the oil companies set dealer margins and hold them accountable for quantity and quality. Make the domestic refineries compete through a fair pricing mechanism with oil imports. The government should charge taxes, particularly the petroleum levy, on products at a higher rate to create buffers when prices are lower.
The local refineries, which cannot compete and are considered strategic for security purposes, should be considered for a shareholding takeover by strategic corporations like Mari Petroleum, Fauji Foundation, Oil and Gas Development Company and PSO to ensure the security of strategic reserves and business integration.
The private sector should set up modern refineries.
Published in Dawn, The Business and Finance Weekly, April 27th, 2020