Risks of volatile oil market

Published March 28, 2022
Thriving on windfall profits, the producers are least bothered to increase production, leaving the oil market to fund managers and hedge funds to make a killing on the paper market.
Thriving on windfall profits, the producers are least bothered to increase production, leaving the oil market to fund managers and hedge funds to make a killing on the paper market.

Prime Minister Imran Khan’s relief package on petroleum products and electricity has come at the most difficult moment. Amid volatile international supplies and prices, its financing is getting tough, the budgetary hole is widening and suppliers are struggling to secure diesel when harvest is at its peak, not only in Pakistan but across many countries — from Vietnam to India and from Indonesia to Bangladesh.

The supply situation is worsened by the Russian invasion of Ukraine and the US-directed gas and oil supply adjustments by European countries. Thriving on windfall profits, the producers are least bothered to increase production, leaving the oil market to fund managers and hedge funds to make a killing on the paper market. Europe is ready to pay anything with its deep pockets for whatever is available in the Middle East to make up for the Russian oil and gas replacement.

That leaves smaller importers like Pakistan at the mercy of speculative market players and exponential premiums. This is making the domestic oil industry nervous at a time when it was already suffering from financial challenges. Imagine that the market leader and state-run Pakistan State Oil (PSO) is sitting on a heap of almost Rs500 billion receivables and yet it has to go an extra mile to scale up imports beyond its normal responsibility.

Unfortunately the workings of the recent petroleum price cut were based on $85-95 per barrel oil and exchange rate at Rs178. The situation changed as prices went beyond $120 and the exchange rate over Rs180

However, the market is getting so unnatural and dirty that even PSO did not get even a single bidder for diesel cargo in the first half of April in the spot market as long term supplier Kuwait Petroleum expressed its inability to provide additional cargo. In the second round, a spot trader came up with a bid for a premium at $10.5 which is a record. The situation with other importers is no better. The next tender may be available even at a higher premium.

In recent weeks, PSO market share in diesel has increased by 3 per cent to 53pc and that of petrol by another 2pc to 43pc as some private firms appear shunning their supply obligations. In fact, the market share of only four firms — PSO, Shell, Attock Petroleum and Total-Parco Pakistan — has gone up to 84pc from about 77pc early this year. This meant about a 7pc cut in the combined market share of 30 something other oil marketing companies (OMC). But this has a cost.

The question then arises that if the country has to bank on just four companies to meet fuel and strategic goals, what is the economic justification for 35 OMCs and almost the same number of more in the pipeline, notwithstanding unusual conditions. “Are they in the oil market just to operate when everything is hunky-dory and earn windfall profits?” asks a former petroleum secretary advocating mergers and consolidation.

The prime minister had announced a Rs10 per litre cut in petroleum prices and a price cap for four months amid the rising global trend. This led to the creation of price differential claims (PDCs). Unfortunately though, all these workings were based on $85-95 per barrel and exchange rate at Rs178. The situation changed as prices went beyond $120 and the exchange rate over Rs180.

To its credit, the government has moved swiftly and has already transferred about Rs20bn into a special account of PSO to make payments to OMCs against their PDCs. The OMCs are now filing their PDCs and would pass through the swift and time-bound approval and payment mechanism.

The government had initially approved Rs20bn along with a procedure for payments to OMCs and refineries on account of PDCs to avoid a shortage of petroleum products in the country. However, the Pakistan State Oil (PSO) pointed out that the procedure prepared by the regulator in consultation with ministries of finance and energy and approved by the Economic Coordination Committee was faulty and would result in product shortages.

It pointed out that PDC was arising on account of the sale of petroleum products while the reimbursement mechanism was based on the procurement of petroleum products. “OMCs will be at a loss if PDC reimbursement is based on procurement rather than sales and private OMCs may shy away from the market and stop selling products in the market,” PSO pointed out.

It highlighted that consumers would only benefit from the PDC or discount on petroleum items when the product is sold by OMCs and “mere procurement will not be sufficient” as companies would tend to hold back sales to earn inventory gains in times of price increase and not to procure in times of price decline — thus leading to a shortage during peak harvesting season.

PDC at the rate of Rs2.28 per litre on the sale of diesel was calculated on February 28 when crude price stood around $100 per barrel but later increased to Rs25 and Rs32 per litre for petrol and diesel respectively as the Arabian crude price increased to $118 per barrel. The amount of PDC thus increased to Rs31.73bn including Rs2.6bn of outstanding PDC of November 1-4. Therefore, another Rs11.73bn has been approved.

On the other hand, the five refineries had stuck up amounts of about Rs23bn on account of outstanding unadjusted input sales tax. The oil industry on a whole has been facing working capital challenges because of large defaults of major OMCs and the resultant reluctance of the banks to increase their credit lines in line with higher international oil prices.

Diesel stocks at present are at a reasonable level of 20-27 days cover. Supplies already line up apparently indicate no shortage issues until mid-May. Like LNG import defaults, the key concern for diesel, however, also remains in case of a default by any supplier to go for higher premiums being offered by bigger importers like European clients.

Published in Dawn, The Business and Finance Weekly, March 28th, 2022

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