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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.