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Cover Story
THE SURGE IN OIL PRICES

Will we be spared?

By SHABBIR H. KAZMI
Sep 06 - 12, 1999

The ministerial monitoring sub-committee of OPEC, in its meeting held on July 30, voiced cautious optimism about the level of adherence by member countries to the reduction in oil production, agreed in March this year and the consequent improvement in prices. Nevertheless, it was noted that the year to date average price of the OPEC Reference Basket was still less than US$ 14/barrel, much below the level witnessed in 1997 and before. Market volatility continued as a result of stocks remaining at levels higher than those which prevailed between 1995-1997 and uncertainty in global oil supply/demand. The members of the sub-committee strongly cautioned against complacency and emphasized the importance of continued strict adherence to agreed production levels by all producers untill expiry of the March 1999 agreement —valid up to March 2000.

With the persistent increase in international prices of crude oil, it has become evident that the government of Pakistan (GoP) will once again increase the prices of POL products. However, sector analysts say that the movement in international prices of crude oil has hardly any impact on local POL prices and it will be the weakest excuse to increase prices of these products. Over the years, development surcharge has been the largest component of the price. According to these analysts, nearly 70 per cent of retail prices of POL products in Pakistan consist of various types of taxes. However, the increase is inevitable because the GoP uses this surcharge to compensate the shortfall in revenue collection.

Therefore, it is important to examine movement of international prices of crude oil and to find out the reasons for the hike. During the last seven months, crude oil prices have touched a new height after the leading oil exporters pledged to retain tight export curbs during the northern hemisphere winter. In a recent meeting of major oil producing countries, it has been once again decided that there will be no increase in crude oil production. These exporters were behind the series of price rescue package that has doubled oil prices, to around US$ 21/barrel from a historic low of less than US$ 10 per barrel in February this year.

Therefore, the name of the game is the level of oil stocks, not the prices. This has been termed as the most important fundamental in the fixation of local POL prices in many countries. Analysts have warned of a winter supply crunch as the curbs steadily wear down excess inventory of POL supplies. globally The latest data shows that global inventories are lower than the bloated levels of last summer but still above the normal volumes of two years ago. Nevertheless, the surplus is soon expected to drain and turn into a shortfall before the turn of the year.

It is also necessary to understand the reason for low prices in the past. Lower international prices of crude oil during the recent past were due to a number of factors. Crude oil prices react to the balance of demand and supply in the short-term and to the rate of investment in the longer term. Basically, it was due to an imbalance between supply and demand. Since 1974 oil producing countries have formally adjusted their crude oil supplies in an effort to improve the balance between supply and demand. Other factors influencing the price of crude oil include accidents, bad weather (increasing demand or halting transport of oil from producers), and other disruptions to production including war or natural disasters.

After understanding the international scenario, possible impact on local prices, it is also necessary to find out why should the GoP increase prices POL prices. Since early nineties, the successive governments in Pakistan have been depending on development surcharge on POL products to compensate for the shortfall in revenue collection. CBR's revenue declined from 12.4 per cent of GDP in 1995-96 to 11.7 per cent in 1996-97 and further to 10.6 per cent in 1997-98. A narrow tax base, inefficient tax collection system, tax evasion, inelasticity of taxes, lower imports and reduction in tariffs have been responsible for the down turn in tax collection. The situation was saved by the decline in international prices of crude oil as the GoP, instead of passing on the benefit to consumers, used the development surcharge to compensate for the shortfall in revenue. The estimated collection of the surcharge for 1998-99 was estimated at around Rs 80 billion. Whereas the collection from all other types of taxes was estimated at around Rs. 300 billion.

The GoP policy has helped in containing the budget deficit— though at the expense of cost pushed inflation in the country. The situation will be very different in the coming months from the past. Bulk of the surcharge will be eroded by increasing crude oil prices. As compared to last year's low of around US$ 10 per barrel in December 1998, crude oil prices have recently risen to US$ 21 per barrel. Considering nearly 50 per cent increase in oil prices coupled with weakening of rupee by 10 per cent, the GoP faces two major problems, pressure on limited foreign exchange reserves and eroding development surcharge.

It seems rather arduous that GoP may succeed in raising additional dollars to finance oil import at enhanced price and to contain trade deficit at target level. Though, the export target has been fixed at US$ 10 billion, there are sufficient reasons to believe that it will be very difficult to achieve the target. There is already an increase in imports of all the commodities including crude oil and POL products. Taking into account the hefty oil import bill, the imports are expected to be around US$ 13 billion for the whole year. This will be despite the forecast for reduction in import of urea and PSF in the second half of current financial year. Therefore, the GoP may not succeed in meeting the IMF conditionality — reduction in trade deficit.

In the current budget the GoP has fixed a target for the collection of Rs 63 billion through development surcharge levied on POL products. With the increase in global prices, it will also be difficult to achieve this target. If the GoP is not able to contain budget deficit to 3.3 per cent of GDP, it will be the breach of another commitment with the IMF.

It is expected that the GoP will once again resort to a hike in POL prices to achieve the development surcharge target to contain budget deficit. The GoP has already increased prices of petroleum products by 10.5 per cent in May this year. Another 7.5 per cent increase in all POL products is expected within this quarter and similar increase in the next quarter. Therefore, the weighted average increase in POL prices will be around 20 per cent during the current financial year.

This is the possible scenario as visualized by many. However, the POL prices in Pakistan are already very high if one compares it with international prices of crude oil. Therefore, any further increase in POL prices will not be justified.

The price of energy products is very important to the economy of the country. The world lives on oil as it is the basic raw material for the plastics and petrochemical industries. Oil is fundamental for the industries and a major component in the agriculture sector. The price of oil is reflected in most of the things one uses/buys. It affects transportation charges, cost of goods and services and the availability of many products including food, water and shelter

There are many factors that influence the prices paid by end consumers of POL products. Crude oil represents less than a quarter of the price of oil products in many countries. When taxes on POL products are raised, end consumers often mistakenly blame the oil producers, but it is really their own governments which are responsible for the hike. Analysts say that even if there is a substantial increase in the price of crude oil, it has only a minor impact on prices being paid by consumers. This is also true about Pakistan.

However, the economic managers of Pakistan do not understand this very basic point. In order to increase the overall revenue collection they continue to increase the applicable tax on POL products. They say, "It is a form of tax being collected from every individual and people should pay it willingly." But they fail to realize that persistent increase in POL price has been a source of inflation, depreciation of local currency and eroding competitiveness of local exporters etc.

Some of the economists say that the persistent increase in POL prices has been due to two reasons — devaluation of the currency and inability of tax regime to improve tax to GDP ratio. However, they say that the problem of devaluation was not the real issue in the past, as the prices were also going down. The lust to generate more revenue by imposing new levies on POL products has been the main reason for increase in POL prices in Pakistan..

Surcharge on POL has been the easiest way to ensure the targeted collection. The surcharge is collected at the time of import of finished products. Similarly it is very easy to collect the levy from three refineries operating in the country. Whereas, to collect Rs 80 billion through various types of taxes is just impossible due to a very corrupt tax collection regime which also encourages tax evasion.

However, by constantly relying on surcharge on POL the government has accepted the failure of tax collectors and shows poor faith in them. At the same time it is also necessary to realize that proving tax exemptions to certain sectors and areas has not helped in broadening the industrial base in the country. But, the policy has been putting additional tax burden on existing tax payers. This also proliferates tax evasion culture in the country because the tax payers feel the pinch as some sectors are still exempted from payment of income tax.

Oil demand will continue to grow strongly and oil will remain the world's single most important source of energy for the foreseeable future. Oil's share of the worldwide energy market will fall from almost 40 per cent in 1995 to less than 37 per cent in year 2020. But oil will still be the world's single largest source of energy. The reduction in oil's market share, in total energy consumed, is largely due to the stronger growth enjoyed by other forms of energy, particularly gas.

Like rest of the world, Pakistan is also highly dependent on oil and gas as a major sources of energy. The profit margins of power plants, cement industry and fertilizer manufacturing units are dependent on prices of oil and gas. Even the price of gas, the second largest source of energy, is linked with international prices of crude oil. The GoP has recently increased the gas (feedstock) price for fertilizer units. Though, it is said that this was done due to pressure of lenders, the fact is that it was an aftermath of linking gas prices with international prices of crude oil.

The import bill of petroleum and petroleum products registered a fall of over 31 per cent last year due to lower average import price despite an overall increase in the quantum products imported. However, the situation is expected to change drastically due to increase in crude oil prices and increased imports of energy products.

OUTLOOK

Higher prices of POL products have been the main reason for cost pushed inflation in the country and erosion of currency value. It was also a reason for intercorporate debt in the energy sector. Part of this problem was overcome when KESC floated Rs 11.5 billion Term Finance Certificates. However, receivables from WAPDA are still a burden on the state-owned enterprises supplying fuel to the largest utility in the country. With the increase in fuel prices the quantum of receivables is once again expected to increase. The GoP needs to take into account this fact before increasing POL prices. The recent imposition of GST on furnace oil has already increased the fuel cost for the power sector.

Persistent increase in furnace oil has been the main source of controversy with the independent power plants (IPPs). Higher fuel cost has also been responsible for deteriorating financial condition of WAPDA and KESC. Any further increase in furnace oil will further dampen the prospects of reaching an amicable resolution with the IPPs.

The controversy with the IPPs has been affecting inflow of foreign investment in the country. It has also adversely affected the relationship with multilateral lenders. The delay in disbursement of power sector restructuring loan amounting to about US$ 500 million is also due to inability of the GoP to resolve controversy with IPPs.

Debt servicing is the largest component of annual expenditures. The debt servicing has gradually emerged as a major constraint on balance of payments and fiscal policies. During the past three years debt servicing has constituted around 45 per cent of the total expenditure and 61 per cent of the total revenue. The size of debt servicing needs to be contained to manageable limits through various policy measures, including debt retirement through the use of privatization proceeds.

In order to accelerate process of privatization, it is necessary to remove all the impediments. In this list, resolution of ongoing controversy with IPPs should be the top priority. Pakistan can raise millions of dollars from privatization of state-owned utilities alone. There is also a need for the privatization of these entities because they need massive investment to expand power generation capacity and revamp transmission and distribution work. At present the GoP does not have funds to invest in the power sector. Besides sale of controlling interest in nationalized commercial banks and Pakistan State Oil Company can also help in early retirement of expensive short-term external debts.

After reaching at a conclusion that prices of POL products play a crucial role in the development of this country, it is necessary that the GoP should not increase their prices further. Rather there should be efforts to collect more of CBR-related revenue by bringing more people into the tax net. There should be no delay in imposing tax on agriculture income. All types of area and industry specific exemptions should be withdrawn. And all types of subsidies should be abolished.

Last but not the least, the GoP should impose quantitative restrictions on import of unnecessary goods. Despite being a signatory to WTO, Pakistan can exercise this option because it continues to suffer from adverse balance of payments situation. All other measures in the past to curb imports have failed and now it is the time to test this option.

 

Local Crude production (US barrels)

Year

Quantity

Daily Average

l995-96

21,062,995

57,549

1994-95

19,857,877

54,405

l993-94

20,674,576

56,643

l992-93

21,895,396

59,987

l991-92

22,468,739

61,396

l990-91

23,487,446

64,349

 

Year

Quantity (Tonnes)

Value
(Million US$)

1995-96

4,230,820

538.02

1994-95

3,867,975

490.60

1993-94

4,191,804

457.77

l992-93

3,998,127

526.99

1991-92

4,047,965

542.97

1990-91

3,972,544

633.49

 

0il Reflnedes Ptoducdon
(Energy products only)
(Tonnes)

 

1995-96

1994-95

1993-94

1992-93

1991-92

1990-91

 

Anaton fuels

585,149

526,577

567,461

572,299

559,362

517,844

 

HOBC

62,156

57,182

70,072

71,003

119,154

105,884

 

Kerosene

506,748

463,281

487,774

511,309

480,087

531,483

 

HSD

1,439,802

1,349,822

1,442,178

1,359,332

1,438,884

1,448,299

 

LDO

253,917

265,210

318,740

289,089

279,696

 

277,159

Furnace oil

1,916,387

1,721,868

1,878,290

1,796,841

2,014,880

2,093,778

 

Motor spirit

968,814

865,326

1928,320

959,555

873,708

 

820,331

Naphtha

104,596

147,523

108,271

98,927

150,636

 

195,889

LPG

36,130

36,844

40,326

36,056

44,818

 

44,973

Total

5,873,699

5,434,233

5,841,432

5,694,411

5,961,225

6,035,640

 

Source: Oil Refineries

 

Energy Products import
(Tonnes)

 

1995-96

1994-95

1993-94

1992-93

1991-92

1990-91

100/LL

Nil

Nil

2,445

1,292

1,559

3,181

HOBC

3,937

Nil

52,167

88,972

81,956

120,336

Kerosene

87,855

145,389

118,767

163,702

55,745

416,826

HSD

5,093,588

4,485,342

4,377,068

3,909,952

3,312,594

2,631,191

Furnace oil

4,748,892

3,865,436

3,243,999

2,447,719

1,823,370

1,138,494

Motor spirit

106,122

156,988

56,094

Nil

Nil

Nil

MTBE

94,499

83,707

59,550

Nil

Nil

Nil

Total

10,134,893

8,736,862

7,910,090

6,611,637

5,275,224

4,310,028

Source: Directorate General Oil

 

Products consumption
(Tonnes)

 

1995-96

1994-95

1993-94

1992-93

1991-92

1990-91

Aviation fuels

460,930

421,883

424,457

411,277

394,819

356,626

HOBC

64,482

112,326

134,714

146,107

217,226

237,492

Kerosene

613,531

601,843

608,201

640,176

632,190

961,976

HSD

6,347,547

5,877,103

5,598,747

5,028,871

4,680,415

4,033,461

LDO

252,208

272,298

312,360

289,791

284,414

272,274

Furnace oil

6,706,797

5,629,187

5,101,719

4,274,696

3,874,664

3,270,770

Motor spirit

11,155,586

1,045,527

1,045,383

1,040,929

899,305

828,669

Total

15,601,081

13,960,167

13,225,581

12,011,847

10,983,033

9,961,268

 Source: Oil Companies Advisory Committee

 

1999 Crude Oil Prices
Current posted price per barrel

1999

Aug 11

$15.25

1999

Aug 6

$14.75

1999

Jul 29

$14.50

1999

Jul 23

$14.00

1999

Jul 20

$13.25

1999

Jul 16

$13.75

1999

Jul 9

$13.25

1999

Jul 2

$12.75

1999

Jun 30

$12.25

1999

Jun 11

$11.50

1999

Jun 7

$11.00

1999

Jun 1

$10.50

1999

May 18

$11.25

1999

May 12

$11.75

1999

Apr 30

$12.25

1999

Apr 22

$11.75

1999

Apr 19

$11.25

1999

Apr 16

$10.75

1999

Apr 5

$10.25

1999

Mar 29

$9.75

1999

Mar 22

$9.50

1999

Mar 17

$9.00

1999

Mar 10

$8.75

1999

Mar 9

$8.50

1999

Mar 4

$8.00

1999

Feb 25

$7.50

1999

Jan 26

$7.00

1999

Jan 13

$7.25

1999

Jan 11

$7.75

1999

Jan 7

$7.50

1999

Jan 4

$7.00

 

1998 Crude Oil Prices - View graphic of WTI-SJV differential

1998

Dec 17

$6.50

1998

Dec 16

$7.00

1998

Dec 10

$6.50

1998

Dec 1

$6.75

1998

Nov 20

$7.00

1998

Nov 18

$7.50

1998

Nov 16

$8.00

1998

Nov 9

$8.50

1998

Oct 19

$9.00

1998

Oct 9

$9.75

1998

Oct 7

$10.25

1998

Sept 29

$10.75

1998

Sept 21

$10.00

1998

Sept 17

$9.50

1998

Sept 4

$9.00

1998

Aug 10

$8.25

1998

Jul 27

$8.75

1998

Jul 20

$8.25

1998

Jul 14

$8.75

1998

Jun 23

$8.25

1998

Jun 22

$7.25

1998

Jun 15

$6.75

1998

Jun 11

$7.25

1998

Jun 10

$7.75

1998

May 29

$8.25

1998

May 21

$7.75

1998

May 13

$8.25

1998

May 1

$8.75

1998

Apr 23

$8.00

1998

Apr 14

$8.25

1998

Mar 31

$8.75

1998

Mar 26

$9.25

1998

Mar 23

$8.75

1998

Mar 19

$7.25

1998

Mar 16

$6.50

1998

Mar 9

$7.25

1998

Mar 6

$7.75

1998

Feb 23

$8.25

1998

Feb 12

$9.00

1998

Feb 4

$9.50

1998

Feb 2

$10.00

1998

Jan 29

$10.50

1998

Jan 27

$10.00

1998

Jan 23

$9.50

1998

Jan 21

$10.00

1998

Jan 9

$10.50

1998

Jan 5

$11.50

1997 Crude Oil Prices

1997

Dec 29

$12.25

1997

Dec 10

$12.75

1997

Dec 1

$13.50

1997

Nov 20

$14.00

1997

Nov 18

$14.50

1997

Nov 6

$15.00

1997

Oct 21

$15.50

1997

Oct 15

$16.00

1997

Oct 13

$16.50

1997

Oct 3

$17.00

1997

Oct 2

$16.25

1997

Sept 29

$15.75

1997

Sept 25

$15.00

1997

Aug 8

$14.50

1997

Aug 4

$14.75

1997

Jul 30

$14.25

1997

Jul 17

$13.50

1997

Jul 14

$13.00

1997

Jul 1

$13.50

1997

Jun 18

$13.00

1997

Jun 6

$13.50

1997

Jun 4

$14.50

1997

May 30

$15.00

1997

May 27

$15.25

1997

May 16

$15.75

1997

May 12

$15.00

1997

Apr 4

$14.25

1997

Apr 1

$15.00

1997

Mar 18

$15.50

1997

Mar 7

$15.00

1997

Feb 28

$14.50

1997

Feb 25

$15.00

1997

Feb 12

$15.75

1997

Feb 7

$16.50

1997

Feb 5

$17.00

1997

Jan 31

$17.50

1997

Jan 24

$18.00

1997

Jan 21

$19.00

1997

Jan 6

$19.50