Cover Story
How oil prices
are hitting our budget
By SHABBIR H. KAZMI
Mar 06 - 12, 2000
The persistent and substantial increase in international prices of
crude oil has caused two serious problems for Pakistan. On the one hand, the balance of
payments situation is going from bad to worse, and on the other hand, the cushion provided
by surcharge on oil and gas, is hardly enough to compensate for the poor collection of
revenue for the time being. Even if the GoP increases prices of petroleum, oil and
lubricant products (POL) and gas, once again, it will be able to address only one issue.
Whereas, the adverse balance of payments situation will continue to present a little
horrifying picture. This feeling, among the economists, is due to almost a complete halt
in the influx of foreign currency funds from multilateral lenders. Despite the best
efforts there is hardly any increase in home remittances and exports to finance the
increased oil import bill. At the same time, the efforts of current economic managers is
worth praising in maintaining the level of foreign currency reserves. It is necessary to
remember that the measures being followed, to contain trade and budget deficit, are only
short-term and they have to come up with long-term sustainable policies.
An eminent economist said that productivity of any economy is inversely
proportional to the cost of energy. Perhaps, our economic managers either do not believe
in this or are unable to raise revenue from any other source except constantly increasing
POL prices. It should also be kept in mind that GoP has increased prices of kerosene oil
and high-speed diesel oil at a much lower rates as compared to the rate at which price of
furnace oil was increased over the years. Furnace oil price, per tonne, was about Rs 2500
in 1994 which now exceeds Rs 8300.
Despite a record increase of 94.8 per cent in the value of POL products
imports during July-Dec 1999, over the corresponding period last year, the Customs Duty
collection went down by Rs 93 million. This reduction in collection was caused due to
duty-free import of the item valuing Rs 12.305 billion (against last year's only Rs 45
million). The duty-free import this year (on value basis) was 32.2 per cent of the total
quantity imported. An increase of 16 per cent occurred in the volume as the value of
imported POL in the first half of this year jumped by Rs 1.896 billion on total
consignment of Rs 38.096 billion against Rs 19.578 billion for the last year. The duty
collection last year in this period was Rs 1.989 billion. The total quantum of POL
products imports during period was 5.6 million tonnes against 4.8 million tonnes for the
corresponding period last year. One needs to find out the reasons behind this phenomenal
increase in quantity, value, and the duty-free import of POL products during the first
half of the current financial year. These figures also indicate that the volume of
duty-free goods imported by the protected industrial sectors has recorded a phenomenal
increase (94.8%) in the first six months of the current financial year. Their value jumped
from Rs 20.435 billion last year to Rs 37.068 billion this year.
One may try to rationalize this policy by saying that increase in
kerosene oil affects the largest segment of rural population which still does not enjoy
the use of natural gas. Similarly, increase in high-speed diesel results in hike in
freight charges. When freight charges go up it accelerates rate of inflation. Therefore,
the GoP was not inclined to increase the prices of these two products. The ultimate result
was that there has been colossal increase in prices of motor-gasoline and furnace oil.
While any increase in motor-gasoline price does not pushes the rate of inflation, the
increase in furnace oil price results in cost-pushed inflation. At the same time it
impairs the cash flow of state-owned power generation and transmission and distribution
entities.
One should take into account that highest percentage of total furnace
oil imported is consumed directly or indirectly by the industry. Any hike in its price
ultimately reduces profit margins of manufacturing sector. According to an analyst, most
of the industries falling in the category of large-scale manufacturing, at present, suffer
from over-supply as well as inefficiency. Prices of their products are already high, when
compared with the international prices of similar products. Even if the manufacturers want
to increase the prices of their products they cannot do so. One such example is cement
industry.
Similarly, power sector enterprises, mainly operating in the public
sector, get the worst impact from hike in furnace oil price. As such these units are fuel
in-efficient and incur higher fuel cost per kilowatt produced, as compared to
international standards. On top of this, when they buy electricity from IPPs they have to,
once again, pay higher price per kilowatt — as cost of fuel is a pass-on factor
according to bulk power purchase agreements. In this context, KESC is the worst hit entity
as its entire power generation is thermal based.
Crude oil prices have been registering constant increase over the last
two years. It has gone up from US$ 7 to US$ 30 per barrel. This has increased the oil
import bill as well as adversely affected the balance of trade situation of the country.
But more importantly, GoP's collection of surcharge on POL products and gas has been
reduced to a very low level. This surcharge is nothing but an indirect tax and an effort
to minimize budget deficit. Since 1994 the policy of raising additional resources through
this surcharge has been a major source of revenue. In the recent past, the collection
under this head was as high as around Rs 90 billion when the CBR related revenue
collection was around Rs 300 billion.
It is understood that the GoP is actively considering another hike in
POL prices. The increase in furnace oil has already been made. One needs to examine the
price hike proposal dispassionately. Any increase in POL prices causes cost-pushed
inflation and the worst sufferer are WAPDA and KESC. Even if they are able to pass on the
increase, in fuel cost to the consumers, it only pushes up the rate of inflation in the
country. Therefore, it is necessary to examine the trend of global crude oil prices as
well as the key indicators of Pakistan's economy in detail before making any decision.
While there has been a persistent increase in crude oil prices over the
last two years, the prices are expected to come down in the coming months. It is based on
the belief that the Organization of Petroleum Exporting Countries (OPEC) may agree to
enhance output in its forthcoming meeting — scheduled in April. Crude oil prices,
even without enhanced production, are expected to go down as the worst of the winter is
over, stocks are high and there is no need to further pile up the inventory.
At the same time there are fears that OPEC members may not agree to
enhance production quota to maintain their current level of high earnings from limited
production. While the USA is exerting pressure on oil producing countries to increase
production, OPEC members may not bow-down before this pressure to safeguard their own
interest. "The US pressure for increasing output by OPEC members seems to be part of
its efforts to contain oil exports from Iraq", an analyst said.
However, it is heartening to note that oil producers realizes that
price volatility in world oil markets is detrimental to both producing and consuming
nations. It is also suggested that greater equilibrium between oil production levels and
consumption will help to avoid this volatility and preserve economic growth globally.
According to a report crude oil prices are expected to drop even before
the OPEC holds its next but crucial meeting. The report says that although OPEC meeting is
most likely to raise production quotas to bring prices down, compliance with output cuts
by the OPEC members had already dropped sharply to about 79 per cent. Crude oil prices
would be lower in April than in January and February, when it hit nine year high. OPEC
members would be able to partially compensate for the drop in their income through
increased production. OPEC is likely to agree to increase output unless prices of oil drop
to unacceptable levels. It is expected that OPEC compliance with output cuts would go even
below 79 per cent recorded in January. The report warns of negative consequences if
non-compliance was allowed to continue. The current oil situation as both low and high
prices contributes to boom and bust in the world oil market. The price of oil at US$ 10 a
barrel was too low and at US$ 30 a barrel is too high.
Keeping in view Pakistan's economy, mounting oil import bill, widening
trade gap and increasing budget deficit, the economic managers do not seem to have many
options at their disposal. Most of their recent measures, make shift arrangements, have
yielded satisfactory results. However, all these measures are short-term and they have to
come-up with a long-term strategy.
Saying this much is not enough, one need to find some tangible
evidence. Though, the list of achievements is not very long, the positive indicators are:
the country has been able to maintain its forex reserves, imports of industrial inputs are
increasing — indicating revival of the economy, budget deficit is at an acceptable
level and the process of industrialization has picked-up. Since the increase in POL prices
is bound to cause cost-pushed inflation, it would be desirable to avoid this and to find
out other alternatives to overcome the prevailing precarious situation.
What could be some possible medium and long term measures? According to
some economists these are: cutting down oil import bill, reducing import of wheat, edible
oil and discouraging imports by imposing higher regulatory duties. One may question, are
these the realistic and workable options? Many analysts say that these are difficult but
achievable targets. Pakistan can conveniently reduce its current import bill of POL and
food items to half. Quantum of furnace oil can be reduced to less than half, alone, by
switching over thermal power plants from oil to gas immediately and by allowing the cement
industry to use natural gas instead of furnace oil. Almost all the power plants operating
in the public sector enjoy the facility of dual-fuel firing system. This effort has
already started as KESC's Bin Qasim power plant is being converted to enable it to use gas
instead of furnace oil.
There are also efforts to increase production of wheat and other food
crops. At the same time, indigenous production of edible oil is on constant increase
— though a substantial quantity of total production and imported edible oil is being
smuggled to the neighbouring countries. Similarly, import bill of chemical fertilizer is
expected to come down with the commencement of DAP manufacturing in the country as well as
enhanced production of urea. If the economic managers are able to bring down import of POL
and food items and also enhance exports, the problem of trade deficit can be overcome to a
large extent.
The overall revival of the economy is expected to yield higher
collection of import duties, sales tax and corporate tax — reducing budget deficit.
Enhanced economic activities, in turn, will also increase the disposable income of
individuals and create additional demand for goods and services in the country.
After years of neglect, policy makers have begun to address, in a more
concerted manner, the basic needs and issues confronting the nation. While the challenges
faced are indeed colossal, a fairly positive initial start has been made in this regard.
The task is being undertaken under aegis of the overall structural reform effort, and the
approach is holistic, rather than piecemeal and/or ad hoc, as was in the past. The first
sign of the dividend from the pursuit of macroeconomic stability is evident in the
deceleration of annual growth in domestic debt servicing.
Therefore, there seems to be no urgent need to increase POL prices for
the time being. Any decision which could possibly ignite an agitation against the present
government must be avoided to ensure broad-based revival of the economy. At the same time
there is an urgent need, on the part of GoP, to restore cordial relationship with
multilateral and bilateral lenders for the resumption of fund flow.
OPEC
During this past week, the OPEC secretary general said that the
Organisation of the Petroleum Exporting Countries would definitely raise output but the
timing and increase had to be carefully managed. "We have to be careful not to create
a problem in the opposite direction. We don't want prices to go back to US$ 10 a
barrel." His words gave little insight into details of output volumes being studied
by OPEC to ease markets and give relief to customers. OPEC members Saudi Arabia and
Venezuela and non-OPEC Mexico met in London during the week to draft a proposal for the
cartel to consider at its forthcoming meeting. The trio said they favoured an output
increase but refused to comment on the timing or volume. Delegates said the three favour a
rise in OPEC output of 1.2 million barrels per day (bpd) from April and another 500,000
bpd later if required. The move would also allow Mexico another 90,000 bpd in exports from
April with other non-OPEC producers like Norway and Oman chipping in.
But the market is anxious that OPEC may not act rapidly enough to ease
output curbs that expire at the end of March. A shortage of petroleum is looming in the
run-up to the summer in the United States, when motorists take to the roads for their
holidays. OPEC producers want to see an output rise as soon as possible but also want to
be careful to build a consensus on policy, Gulf sources familiar with the trio said:
"There is for sure a goal to increase the production as soon as possible in order to
bring the market to a balanced position. We have to keep in mind the coherence of the
group. We don't like to affect the group that rescued the market. Saudi Arabia will never
allow a crude shortage and it will never let down its customers.
Venezuelan oil workers went on indefinite strike on March 3, in protest
at the government's refusal to resume talks on a collective labour agreement. But state
oil company of Venezuela had previously said it can guarantee supply of its 2.72 bpd
production if the planned strike went ahead. The US President assured lawmakers that he
was prepared to consider releasing oil from the nation's emergency stockpile to lower
gasoline prices if OPEC fails to pump more crude after the cartel meeting. Northeast
lawmakers have for weeks been demanding White House action to ease the pressure on their
constituents' home heating oil costs, which have more than doubled this winter in the face
of tight oil supply and high crude prices.
