Energy sector, having enormous potential to bring in the much sought after investment both from home and external resources, is gradually assuming a greater role as in the economic development of Pakistan.

Apart from oil and gas exploration segment which attracted the major part of the total investment came in during the current financial year, the oil marketing companies did not lag behind and made significant investment in various dimensions of the oil sector from construction of oil pipeline project, expansion in oil storage capacity project and tremendous improvement in customer services through introduction of most modern outlets in all the major cities of the country.

Pakistan State Oil (PSO) despite carrying a label of a public sector entity, and facing tough competitions from multinational contenders in the market performed superbly in marketing, operational and investment activities reflected in the financial results achieved by the company.

It was because of the professional management and consolidation of the resources that despite the revenue drop and a record provision of Rs2 billion made to taxes, PSO earned an all-time record profit before tax of Rs5.1 billion for the financial year ended June 30, 2002.

The gross profit increased by 49 per cent while profit after tax rose to Rs3.2 billion registers a growth of 42 per cent over prior year period. In addition the company absorbed the balance financial impact of Rs408 million on account of Voluntary Separation Scheme (VSS) offered in April 2001. Without adjustments and inventory gains/ losses, operating profit of the company grew by an impressive 32 per cent over the prior year. The profit increase is primarily due to innovative marketing strategies, organizational restructuring, enhanced product mix, revamping of internal systems with improved productivity along with the partial impact or enhanced margins during the last quarter of the financial year 2002.

New Vision Development Program remained the key area of investment as the company is deriving substantial volume from these state-of-the-art outlets. During financial year 2002, the company made an all time record capital expenditure of Rs1430 million, while the total expenditure during the last six years i.e. from 1996-2002 exceeded Rs6.6 billion.

With rigorous follow-up on stuck-up claims of Rs7.5 billion on account of price differential, the government finally decided to reimburse oil marketing companies by incorporating a nominal cushion in consumer prices of Mogas, HSD, SKO and LDO up to the final settlement of entire claim which is expected to be settled by December 2003.

The company also won the ICAP-ICMAP Best Annual Report Presentation Award for its impressive Annual Report. Shaukat Aziz, Minister for Finance while giving away the award acknowledged the remarkable performance of the public Sector Company competing with multinational firms. PSO also won the Karachi Stock Exchange Top 25 Companies Award for the record 18th consecutive year.

OVERVIEW

Financial year 2002 experienced global economic recession triggered by September 11, 2001 incident in the USA followed by coalition military operation in Afghanistan. Pakistan's proximity to Afghanistan and a war like situation on its b order with India put the country's economy under tremendous pressure resulting in lower domestic consumption.

During the first half of the year, the international crude and POL product prices and consumption dropped sharply with trickle-down effect in domestic consumption and prices. With the upward movement in international prices and increased demand of POL products after January 2002, the local demand and prices also recovered and followed by the same trend however, the consumption grew at a slower pace. In the second half of the financial year 2002, the overall POL industry showed a growth of one per cent as compared to negative growth of 9.1 per cent registered during July-December 2001 period thus partially off setting the sharp drop on cumulative basis.

In Financial year 2002, the overall POL consumption in Pakistan was 17.3 million tons, down by 4 per cent over the preceding year, which had been growing at a compounded annual growth rate of 7 per cent during the last two decades. The decline in consumption was primarily due to the reduced consumption of fuel oil, which registered a negative growth of 6.3 per cent. Consumption of Motor Gasoline, which has been declining at around 3 per cent during the last five years, registered a decline of 2 per cent despite the CNG & LPG substitution, fluctuating prices and inflow of smuggled product from across the adjacent borders. HSD demand also witnessed a marginal decline of 0.33 per cent while SKO and LDO demand also dropped by 18.5 per cent and 14.2 per cent respectively.

Local refineries produced 9.5 million tons while the deficit requirement of around 9.3 million tons was imported. In financial year 2002 furnace oil and HSD represented 87 per cent of total POL demand were imported to the tune of 4.6 & 4.7 million tons respectively. POL products like Mogas and Naphtha became surplus since PARCO came on stream in September 2000. As a result approximately 170,600 million tons of Mogas and 385,000 million tons of Naphtha were exported during the year ended June 30, 2002.

In order to extend the cross country pipeline Tarujabba (Peshawar) from Machike, PSO and ARL signed a Memorandum of Understanding for the construction of 470 km new white oil pipeline, with ultimate capacity of 2 million tons to an estimated cost of Rs10 billion. Work on $481 million Pak Arab Pipeline Company Project, which has been delayed owing to the September 11 incident is now progressing smoothly and is, expected to be completed by December 2003.

MARGIN

With the constant follow-up by Oil Marketing Companies on enhancement of margins that had been frozen for the past several years, the government realized the financial distress being faced by the oil marketing companies, specifically after linking the domestic price mechanism with international price fluctuations from July 1, 2001 announced phased upward revision in their margins up to 3.5 per cent effective July 1, 2002, similarly dealers margins were also enhanced to 4 per cent.

MARKET SHARE

Despite all the adverse factors, PSO sold approximately 11.5 million tons of POL products. Reduced off-takes by HUBCO (around 9.9 million tons) primarily resulted in sales volume drop of 6.3 per cent over prior year. Had the consumption level of HUBCO remained at the preceding year's level, the company would have not only achieved almost the similar volume sold in financial year 2001 but would have also maintained its market participation as fuel oil demand of this power utility company has been met by PSO being its sole supplier under long term Fuel Supply Agreement.

With the launch of the new Vision concept, PSO has not only been able to arrest its chronic decline in market share of Mogas, which had been declining consistently at a CAGR of 2.5 per cent per annum during the last several years, but was also able to gain 1 per cent share during the fiscal year ended June 30, 2001. During financial year 2002, PSO successfully maintained its market share at 40 per cent despite the stiff competition from existing players, induction of new entrants and logistics issues.

PSO managed to contain the decline in market share of HSD, which had also been registering sharply downturn in market share at a CAGR of 4.7 per cent till financial year 2000. During financial year 2002, the company registered a market share of over 59 per cent despite the overall low agricultural demand as well as restricted supplies to agricultural areas adjacent to Indian border, which have been solely fed by PSO. In addition, on going New Vision construction activity on a number of outlet and defence businesses won by competition for financial year 2002 also led to volume drop.

However, the company regained the defence business for financial year 2003 for the supply of 34,000 MTs of Mogas and 117,000 MTs of HSD business from Pakistan Railways for the period of three years ending June 2005. With the acquisition of these businesses, PSO would not only further improve its sales performance but also enhance its market share in Mogas & HSD.

After the steady decline in lubricants market share for the last several years, PSO regained 1 per cent market share from the competition and thus increased its participation to 39 per cent. This reversal in trend was achieved owing to the formation of complete value chain under the new business unit concept implemented by PSO. Other initiative featuring the extension of product line, technical seminars and improved customer services also contributed to market share increase.

In order to ensure the availability and quality of PSO lubricants, the company expanded its lube shop network to 76 while another 50 are in development stages. The company also introduced ěFree Lube Deliveryî at nine locations to provide prompt service at customer's outlets without any extra cost in addition. The company also introduced dedicated packed lubricant container service to transport product to all upcountry storage points in attractive colour scheme. The launch of these services has helped the company introducing flow of spurious and counterfeit products with complete customer satisfaction through satellite tracking.

CAMPAIGNS

During financial year 2002, New Vision Network expanded to 503 retail outlets at an average construction rate of 2.2 days per outlet. The company successfully equipped 600 retail outlets with Internet facility while C-Store network expanded to 56, and 44 CNG facilities were operational. Company-Owned and Company-Operated outlets, being used as the model stations with the highest standards of services, were expanded to 26 while another 30 sites would be added during financial year 2003.

The latest launch of "PSO Loyalty Card" has been the most innovative marketing initiative, which has not only enabled the customer to earn PSO Loyalty Points redeemable throughout the country, but has also offered them attractive discounts for purchases at a large number of merchant outlets.

To enhance its brand equity, a series of successful sales promotions and corporate campaigns backed by strong media support have been launched. In its endeavour to work beyond customer's satisfaction, PSO introduced computerized complaint lodging system with a toll-free number. The company has the distinction of being the first oil marketing company to provide toll-free number at the Customer Services Department to offer free calling facility to its customers round the clock.

After the construction of the tallest signs ever built in Pakistan (around 120 feet high), PSO installed the mega hoarding 115X47 feet at Qurban Service Station, Karachi, which is also the largest hoarding ever built by any company in the country.

PSO has been successful in acquiring Defence Energy Support Center contract for the supply of 39,000 MTs of Jet A-1 to Afghanistan on competitive bidding against international tender through World Fuel Services, Miami, USA. The company also renewed and regained jet-A1 business of leading international air carriers like Air France, Singapore Airlines, Gulf Air, Saudia etc. Construction of Info-plane and Fuel Farm Facilities at new terminal Complex Lahore is in final stages. With the commissioning of the new terminal complex, PSO would be meeting 100 per cent fuel requirements of the emerging hub of the region.

PSO has been maintaining strong focus on quality assurance as indicated by the expansion of Mobile Quality Testing Unit Network from 12 to 16. These testing units are being operated on dual-shift basis in major cities of the country to ensure companies customer satisfaction.

OPERATIONS

During Financial Year 2002, PSO signed long-term Sale and Purchase agreements with National Refinery and Bosicor Refinery in addition to the existing agreement with PRL and PARCO. With the execution of these agreements, the company has made an access to assured and cost-effective supplies. The company has successfully negotiated with Kuwait Petroleum Company for the supply of 0.5 per cent Sulphur Gas Oil for the period 2003-05 on attractive rates. During July-December 2002, PSO would import 1.6 milion tons of low Sulphur Gas Oil from KPG.

In Fuel Oil, the company signed the term contract with 3 international suppliers for 2.4 million tons of High Sulphur Fuel Oil and 0.4 million tons of Low Sulphur Fuel Oil during the period January-December 2002.

During the year ended June 30, 2002, PSO imported gas oil and fuel oil to the tune of 3.3 and 4.2 million tons respectively.

Consequent upon WAPDA's decision to import a portion of its annual fuel oil requirement, PSO and WAPDA entered into hospitality agreement that would facilitate the power utility to store its imported product at Zulfiqarabad Oil Terminal for onward shipment to power generation units. With the new hospitality arrangement with WAPDA previously done with Shell, PSO would generate certain assured and guaranteed ancillary profits. Parallel to this, PSO became the first Oil Company in Pakistan to win the first ever-international tender floated by WAPDA against international competitions for the supply of 110,000 MTs of fuel oil during September.

The company has been importing around 0.6 million tons of LSFO for KAPCO at a premium higher than HSFO resulting in an extra expenditure of $12 million a year. In order to save precious foreign exchange, PSO has now started supplying 20,000 MTs a month or 240,000 MTs a year LSFO from Attock Refinery to KAPCO which would bring substantial savings to national exchequer. Gradually the quantity will be increased to 400,000 MTs a year. Besides saving foreign exchange, local LSFO will also narrow down the current price differential between HSFO & LSFO while the outstanding amount on account of HSFO/ LSFO price differential claims against WAPDA would not grow at historically higher rates.

PSO also helped save $40 million foreign exchange reserves by utilizing two grants for the procurement of fuel oil provided by the Japanese Government with the prescribed time frame. PSO not only utilized the entire grant but also remitted to the government the entire amount equivalent to the local currency. As the payment terms of this grant were very attractive for suppliers, the cost of import was lower than normal and PSO, being a customer friendly company passed on the benefit to this lower cost savings to the consumers.

The company also provided storage and handling facility to Attock Refinery for the export of surplus Naphtha being produced by them. A similar facility was also extended to PARCO for its surplus Mogas of 300,000 MTs.

In order to enhance its storage capacity at Zulfiqar Oil Terminal, the company has started constructing 2 additional storage tanks each 30,000 tons capacity for handling and storing crude oil on behalf of Bosicor Refinery. The company is to enhance storage and handling capacity at depots and installation and to bring them at par with HSE standards undertook various other projects.

PSO being fully committed to implement total quality management approach has achieved ISO 9000 certification for its six terminals while the balance storage would be made ISO compliant in the next couple of years.

The company has strengthened its internal controls specifically in supply chain area by implementing computerized load acknowledgement system, which is aimed at preventing misappropriation of products in transit and ensures prompt delivery of products to customers and depots. To ensure proper supplies to local retail outlets, fleet management plan has been implemented at Karachi, Lahore and Islamabad, which would be extended gradually to other major cities of the country.

CHALLENGES

While PSO has emerged as a true model company for contemporary businesses the continuously changing business scenarios nevertheless, call for constant realignment and improvement specifically under complete deregulation regime. Induction of new players, cutthroat competition and menace of smuggled and spurious products as well as threat of product substitution are a few major challenges for the oil marketing industry in Pakistan.

Deregulation of HSD has indicated the new paradigm. Expected further deregulation of the petroleum sector would lead to price war among the existing as well as new players resulting in margin erosions.

In an increasing competitive and deregulated environment with free market conditions, an optimum balance between earnings and market share will be the top priority of the management.

Higher operating efficiencies with continuous innovation and improvement in business processes are the perquisites for future expansion and growth in shareholders' value.

The challenges of the coming year would demand an even greater dexterity and ability to respond to rapidly changing external environment. With the various new initiatives already undertaken in the recent years PSO is confident of continuing its positive performance both in terms of sales volume and profitability.

Display of highly impressive performance during financial year 2002 has however endorsed that the strategic initiatives undertaken by the management are taking PSO to the path of glory and stability — A role model set for other companies in the public sector.