In the last few weeks, various articles have appeared
in newspapers criticizing the increase in the prices of petroleum
products, particularly the prices of diesel. Most of the writeups do not
reflect the factual position, which therefore tends to mislead the
reader and create doubts in their minds about the pricing mechanism for
petroleum products. In order to remove these doubts, it is therefore
essential to explain the mechanism that is in place since the last
one-year and which has been strictly followed by the Oil Companies
Advisory Committee (OCAC). It also needs to be mentioned that the
pricing mechanism followed by OCAC has been approved by the Government
and is a step towards deregulating the petroleum sector.
At the outset, it is necessary to point out that most
of the writeups written link the international crude oil prices with the
trend of petroleum product prices in Pakistan. Indeed this is a
reasonable indicator but often tends to distort results. The correct
indicator is to analyze the trend of product prices in the international
market. Product prices fluctuate based on the demand and supply
situation that is prevalent at any given point in time. The differential
between the FOB price of crude oil and product prices represents the
refiners/traders margin. The region in which a country is situated is
also an important factor. Most analysts tend to compare trends in the
price of Brent crude oil with the consumer prices in Pakistan. This is
not a reasonable indicator. Pakistan is situated in close proximity to
the Middle East region and therefore any analysis that is done should
relate to the Arab Gulf region.
In order to analyze the trend, given below is the
data pertaining to the FOB price per barrel of Arab Light crude with the
FOB price of diesel in the region for the last three months:
It can be seen from the above table that there is a
gap between the price of a particular product and that of crude oil.
Although the crude oil price fell on average during June 2002 by $ 0.68
per barrel a drop of 2.7%, the price of diesel increased marginally but
the gap between the price of crude oil and diesel increased by $ 0.73
per berrel. The FOB price of diesel gets reflected in the working of
consuxner prices. Based on newspaper reports and articles that crude oil
prices have declined, the public perception is that product prices will
also show a decline. When the consumer price does not follow the same
trend, as that of crude oil as seen in the chart above, there is general
criticism regarding the whole pricing mechanism.
Freight is another fmpo:rtant factor that should not
be forgotten. Grude oil is transported in tankers usually called
"dirty tankers," while finished products are transported in
tankers called "clean tankers". The freight for products is
therefore substantially higher than that of crude oil.
Consumer prices in Pakistan are made up of the
The ex-refinery price of a product, which is paid to
local refineries, equates to the landed cost of the product. In other
words it relates to the import parity price of the product if the same
were to be imported. The base price relates to the relevant products FOB
price averaged for the fortnight as quoted in the Arab Gulf region to
which are added other elements like freight, L/c and bank charges,
wharfage etc to arrive at the refinery price.
Government levies are the prerogative of the
Government and are fixed in accordance with the needs of the Government.
Petroleum products are an important source of any Government's revenue
and Pakistan is no exception. The currcut Government levies on petrol
are Rs. 12.87/litre representing excise duty and petroleum development
levy, while on diesel it is Rs. 2.76/litre representing petroleum
development levy only.
Inland freight is used to equate the prices of the
products all across Pakistan. In order to do this, 29 core depot
locations have been identified and prices are kept constant over these
locations. The product wise cost of product transportation from
refineries or imports to these 29 locations is allocated to the
respective product and is called primary transport cost. This element
represents actual cost and does not include any profit element for the
marketing companies. The cost of transporting product from these
aforementioned core 29 depot locations to the respective retail outlet
is called secondary transport cost and varies in accordance with the
distance of the retail outlet from the nearest depot. This cost is over
and above the fixed sale price determined by OCAC for the 29 core depot
locations. Cartage rates for the transporters are revised on a quarterly
basis to reflect both the upward/downward movement in the prices of
The Government fixes the distributor and dealer
margins, which represent the profit element for the oil marketing
company and their dealers. These margins are represented as a percentage
of the fixed sale price. Till February 2002, the margins were 2% and 3%
respectively for the OMC's and dealers when they were revised to 3% and
3.5% respectively. From July 2002, these have been fixed at 3.5% for
OMCs and 4% for dealers.
Sales tax is the last element in the consumer pricing
and is calculated at 15% of the price before sales tax. This varies in
accordance with the movement in the price of various products based on
the FOB value and the Rupee/Dollar parity rate.
It is hoped that the above article will help in
removing the misgivings in the minds of analysts about the pricing
mechanism of petroleum products and will also create a better
understanding of the whole process in the minds of the general public.