Historically Pakistan has remained a net importer of crude oil and petroleum products. The rising trend in international oil prices is likely to erode country’s paltry foreign exchange reserves. The depreciating local currency offers an opportunity to the government to increase petroleum prices, which will also increase collection of levies imposed on energy products. However, the immediate fallout will be increase in cost of production/doing business that could render Pakistani exporters un-competitive in the global markets.
First, it is important to understand likely movement of crude oil prices in 2018. A closer look at the graph picked up from one of the Bloomberg stories indicates that during the second half of 2017, prices of two international benchmarks Brent and WTI, have increased by approximately 30%. According to some forecast Brent price is expected to average US$60/barrel in 2018, while WTI is seen at about US$55/barrel. The anticipated price movement raises some basic questions. How much will be the increase in US oil production? How would OPEC carve its policy about production quantum to retain its market share? Will the global economy be strong enough to absorb extra barrels produced?
There is a lot of divergence one finds between the forecast of different analysts about the US production. However, almost all the analysts are very optimistic about US shale supply growth next year. Crude oil production of the US is expected to hit record levels next year, buoyed mainly by OPEC production cuts in 2017. Reduced OPEC supply has helped in containing the glut and translated into higher prices. This has also been a boon to oil producers in North America, who have been able to lock in prices for supplies going forward, giving the financial certainty to invest in drilling.
According to Energy Information Administration (EIA), the US crude production is likely to surpass record output of 10 million barrels/day next year. The reduction in glut, translating into higher prices, can also encourage OPEC and non-OPEC producers to bid farewell to production cuts. The unabated collective increase in production may once again exceed the global oil consumption next year and initiate decline in global prices in 2018.
Another graph picked up from a Bloomberg story gives credence to various narratives. Oil prices are expected to hover above US$60/barrel following a decision by OPEC and its allies to extend supply cutbacks through the end of 2018. Global stockpiles will remain below seasonal levels and continue to shrink through the second quarter of next year. Saudi Arabian Oil Minister Khalid Al-Falih is optimistic about the global oil-cuts pact, yet believes that oil inventories won’t be near the level needed by the time OPEC meets in June. Kuwait’s new oil minister Bakheet Al-Rashidi expects healthy crude demand next year and sees consumption growing by 1.5 million barrels/day next year.
The impact of rising international crude oil prices on Pakistan has to be understood with two perspectives: 1) impact on country’s economy and 2) impact on exploration and production companies (E&Ps) and other constituents of energy chain. While the country’s foreign exchange are likely to erode faster, the incumbent government will get the booty in the shape of higher collection of levies on energy products, which are calculated as a percentage of landed cost of these products.
One side of the coin tells that the top line of E&Ps will increase with the hike in international crude oil prices. The resulting improvement in bottom line may enable them to distribute higher dividend, in such a scenario the government will be the biggest beneficiary as all the large E&Ps listed at the local bourse are state owned enterprises. This may bring back foreign investors to Pakistan Stock Exchange (PSX).
However, the other side of coin shows a bleaker picture. Energy chain companies are victim of circular debt. The hike in prices of products sold will boost the top line, but there are bigger fears of mounting receivables. The hike in electricity and gas tariffs is likely to encourage the consumers to pilfer more of energy products that will reduce the recoveries. The emerging situation will not allow them to make timely and full payments to producers and suppliers (E&Ps, refineries, OMCs and gas distribution companies).
It is anticipated that with the rise in prices of energy products cost of production and transportation will also increase. A point to ponder is that key industries of Pakistan i.e. textiles and clothing, cement and fertilizer, already finding it difficult to compete in the global markets would come under further pressure. It is already on record that Pakistan has failed in boosting its textiles and clothing export despite grant of GSP Plus status by the European Union. Fertilizer export was not possible without substantial subsidy. Cement manufactures are also finding it difficult to compete in the global markets. Sugar mills are also carrying huge inventory as they can’t solicit export orders.
Moral of the story
The latest data about Pakistan’s international trade portrays a very gloomy picture and demands immediate remedial steps by the government. During first five months of the current financial year exports grew by paltry 12% to US$9.79 billion, as against this, imports grew by almost double the rate to US$21.88 billion. This clearly suggests that sooner than later Pakistan will be forced to approach the lender of last resort, International Monetary Fund (IMF).