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Rising Oil Prices: Adding Fuel To Fire

Pakistan is a net oil importer and meets about 75 percent of needs through imports. Oil imports carry the heaviest weight in total imports of the country. Pakistan has a total refining capacity to process around 400,000 bpd or about 19MTPA of crude oil, against the current demand of 24MTPA. Total global refining capacity is 97 million bpd, and Pakistan, with nominal world share of 0.4 percent, is ranked 48th. Demand for oil products in the country is expected to grow steadily at seven percent on year-on-year basis, according to recent studies, in particular for the furnace oil, motor spirit, diesel and aviation fuel, which accounts for 78 percent of total oil demand. Thus, the demand-supply gap will continue to strain heavily on the imports in future, if oil refining capacity is not added at a large scale.

The rising oil prices are the major concern for all the developing economies and Pakistan is suffering from it too. Higher oil prices will stoke inflation and put pressure on the balance of payment position and foreign exchange reserves. Since oil is the major source of electricity generation in Pakistan, the hike in petroleum products’ prices may make it difficult to significantly ease power outages. The cost-push inflation caused by the oil price hike ensues from our reliance on oil as major source of energy. We produce 64 percent of our energy from oil, gas and coal-based operations. Besides increasing domestic oil output, we will have to gradually do away with the use of oil for power generation. An increase in oil price leads to inflation, increase budget deficit and puts downward pressure on exchange rate, which makes imports more expensive. The increase in oil price has further effect on the daily consumption pattern of households.

Quantum imports of all POL products (particularly HSD and petrol), have recorded significant growth this year, indicating strong transport sector activity. This has also corresponded with a hefty increase in imports of buses and heavy commercial vehicles. Similarly, an increase in power generation from furnace oil in H1-FY17 led to higher imports of the fuel. Up till Q1-FY17, the savings on oil import payments had been offsetting rising non-oil imports and partially compensating for declining exports. This, coupled with growing remittances (till FY16), had been providing adequate forex cover to the external account and indirectly contributing to reserve accretion. However, this comfort has now started to diminish. Moreover, Pakistan’s import bill may further increase with the surge in oil prices following the supply cut agreement between OPEC and key non-OPEC members in December 2016.

 

With oil payments rising in Q2-FY17 on a year-on-year basis for the first time from Q1-FY15 onwards, the overall import bill has begun to swell. Even though exports reversed their multi-year declining trend and rose 11.3 percent, this uptick was insufficient to offset the rise in the import bill. As a result, the trade deficit widened to US$32 billion in 2016-17– the highest yearly trade gap. Owing to the swelling trade deficit, the balance of payments of the country is now projected to worsen to levels never seen in the past. Finance Ministry in its budget documents had revised the current account deficit projection to $8.4 billion for the year ended 2016-17 fiscal, but actually it turned out to be $12 billion. This current account deficit was highest-ever in the history of Pakistan, and with news of further increase in deficit, it could virtually erode the much-touted forex reserves within next 4 months.

Independent economists say that ever-increasing trade deficit has finally exposed vulnerabilities of Pakistan’s economy. Despite incentives offered by the government, exports were not picking up, as these packages remained partially funded causing resentment among exporters.

The International Monetary Fund (IMF) has cautioned Pakistan and other oil importers against rising oil bills for 2017 as a result of the rising global prices. The oil import bills are expected to be around 30 percent higher than the previous year. Any further increases could affect consumption, increase fiscal risks, and worsen external imbalances, the IMF has signaled in its May 2017 Regional Economic Outlook for the Middle East, the Gulf, and North Africa, Afghanistan and Pakistan (MENAP). Pakistan’s growth prospects continue to improve if inflation remains contained. However, weak fiscal performance and pressures in the external account pose a challenge. Efforts to reverse the current imbalances and continued implementation of structural reforms would be needed for sustaining and accelerating growth and improving welfare.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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