Higher crude prices may escalate trade deficit FRP, $6.5 billion

 Oct 10 - 16, 2005

President General Pervez Musharraf has said that the government will set up oil refineries at Gwadar to serve as a regional trade hut and provide cost effective fuel for sustaining higher economic growth.

The government is striving to develop gas, coal, water and alternate energy sources as a part of its strategy to minimize the country's dependence on imported oil.

President Musharraf observed that Pakistan has reduced its dependence on oil for power generation from 70 to 59 percent through greater usage of gas and intends to bring it down to 30 percent.

Pakistan also needs big water reservoirs to meet its growing water and energy requirements. Pakistan is lucky to have large coal deposits and other alternate energy sources available within the country but their non-utilization in favor of expensive oil generated power burdened the national exchequer, adversely affecting the economic growth. Though the country has abundant natural resources and human capital to rise and become a modern country in the comity of nations, yet these resources need a direction and a strong will to use them productively.

Despite a declared policy of shifting dependence on costly imports of oil and shifting on natural gas, the import of oil continues to pose a serious threat to the economy. It is estimated that during the current financial year the oil import bill may exceed to $6 billion.

According to recent ADB report, the trade deficit target at US$5.8billion is higher than US$4.1bn estimated earlier. However, this estimate is almost at par with the FY05 actual trade deficit at around US$6.05billion.

Higher oil prices are mainly to blame along with steady growth in domestic petroleum demand. The trade deficit may aggravate further if crude oil internationally maintains its ascending trend. Further, the ADB estimates the current account deficit for FY06 at 2.5-3.0%.

The Asian Development Bank (ADB) has, however, commended Pakistan's future economic prospects by stating the economy as stable with sound macroeconomic fundamentals.

In its recent comments on Pakistan economy, it appreciated what it called boosting private investment and expanding development expenditures.

Further, improved political and economic relations of both Pakistan and India would also increase bilateral trade as well as promote foreign investment due to reductions of external security concerns. ADB has also given its estimates on Pakistan's various economic indicators.

The following table compares ADB's projections with the estimates that were set forth at the beginning of the prevailing fiscal year.

Projected Key Economic Indicators for FY06 ADB Initial targets set for Pakistan

GDP growth (%) 6.5- 7.0%

Agriculture growth (%) 3.0%- 4.8%

Large-scale manufacturing growth (%) 11.0%-10.7%

Inflation (%) 8.0%- 8.5%

Trade deficit (US$ billion) 4.1-5.8

On one hand, the macro economic fundamentals portray healthy features of the economy in Pakistan, however, things were not so bright at micro level as compared to the strong macro indicators. It seems that the economic managers focused their entire attention on the rosy picture of the economy at macro level which resulted in an imbalance of relationship between macro and micro indicators. The root cause of distracting the economy at micro level is of course the unabated increase in oil prices which adversely affected the budget of the low income groups.

The bank fears that high oil prices can negatively affect the economy. It further states that expansionary fiscal policy, high oil prices and the large monetary overhang may make it difficult to contain inflation. We feel that inflationary numbers are likely to depict a consolidating trend in the coming months as the impact of higher domestic petroleum prices starts to reflect in consumer prices. Oil inflation has a chain effect on most economic sub-sectors as it effectively raises the aggregate cost of industrial production. Consequently, we may see further tightening in the monetary stance. As a prelude to further hikes in secondary market yields, an increment in the SBP discount rate from the existing level at 9% may be imperative given the narrow differential between the discount rate and the one-year Treasury bill yield.

Actually, the central bank had increased the discount rate of the banks to use it as an effective check on the growing inflation in the country. However, that step apparently failed to produce visible results in the backdrop of ever increasing price inflation in the country. Instead of helping to contain the mounting inflation, the increasing interest rates of the banking sector have seriously affected the booming consumer market in Pakistan. It was the low interest rates which gave robust demand growth to the leasing sector which was heavily engaged in car financing business.

Another sector which had a serious blow of the rising interest rates was housing finance. Due to higher interest rates, the booming real estate business has started to move in the reverse gear, and adversely affecting the allied construction industry as the chain effect of the increasing interest rates. The economic managers would have to give a second thought to the upward trend of the interest rates in Pakistan.

It is the oil price which had a direct hit to the transport sector which also demonstrated recently by calling a wheel jam strike in Karachi. The transporters were demanding increase in the fares which have already touched the top line. Now is the time that the government should take some concrete steps to resolve the issue at least for a predictable time. One of the workable solutions is to declare Karachi as "CNG City" by converting all public transport vehicles from oil to CNG, which calls to work on war footings to give a relief to the common man especially in the urban centers of the country.

ADB's economic growth target at 6.5% is slightly lower than 7% set at the beginning of the year. This is on account of lower agriculture growth, even though large-scale manufacturing growth is projected to slightly exceed the target. Agriculture sector growth during FY06 is to be lower on account of the high base effect of last year.

The ADB report states that the damage caused by recent floods to standing crops will also depress agricultural production. Overall, agriculture sector prospects are sanguine ensuing from satisfactory water supply and favorable weather conditions. Large-scale manufacturing growth expectations are upbeat on the back of robust domestic and external demand.

According to ADB, one contributing factor is the positive amendments in tax levied on tradable goods. The inflation target for FY06 set by the ADB is at 8.5%. This is higher than the 8% estimate set earlier. ADB has mentioned inflation to be a serious threat for Pakistan's economic prospects.

It is interesting to note that while every segment of the economy was suffering seriously due to unrealistic increase in fuel prices, the oil marketing companies as well as the refineries were making huge profits of the oil bonanza.

The profits of the oil marketing companies as well as oil refineries have taken a quantum leap during most of 2005 on the back of upbeat trend of crude oil prices. It is significant to note that consumption of petroleum products in the country increased to 15.13million MT during the FY05 as against 13.72m MT the last year, registering a growth at 10%.

The robust demand growth helped to improves sales of the oil companies and the refineries operating in Pakistan. Crude oil prices recently peaked to the US$70/bbl level while Benchmark NY crude oil is hovering around the US$66/bbl level.

According to energy analysts, higher oil prices also benefit the refineries in the form of inventory gains. †During 2005, the average price of light Arabian crude depicted an increment at 36.9%. Moreover, the FOB prices for petroleum products attained record increases, with average prices of HSD and Kerosene rising by over 50%.

Sanguine white oil products demand fuelled by massive auto sales and greater industrial activity resulted in higher capacity utilization for the refineries during FY05.

The Pakistan Refinery Limited (PRL) which operates at a capacity of 2.15million MT compared to 2.05m MT last year on the back of optimized production yield and improved market situation for product uplift. In the backdrop of the ongoing surge in oil consumption, the PRL posted a sanguine upsurge of 56% at Rs44bn compared to Rs28billion during the previous year. Pakistan Refinery's FY05 earnings at Rs1, 722 million portrayed a 134% YoY improvement. PRL's gross margins during FY05 improved 1.8pp to 6.7% on the back of the substantial surge in oil and petroleum product prices. Average international crude oil prices during FY05 were up by approx. 30%. Operating expenses depicted a massive surge of 141% while other income dropped 2%. Financial charges also increased 63% on the back of higher markup on running finance. PRL's EPS during FY05 amounted to Rs86.08 compared to Rs36.69 last year.

Effective tax rate was slightly lower despite an increase in taxation expenditure by 121% to Rs879million, the effective tax rate of PRL was at 33.8%, lower 1.3pps over 35.1% during FY04 thereby contributing to the growth in the bottom line.



Shell Pakistan's earnings for the period were estimated at Rs1,925million, 28% higher compared to Rs1,508million during FY04. Final cash dividend is anticipated at Rs34/share, thereby taking the cumulative FY05 cash payout to Rs42/share. Last year, Shell Pakistan had declared Rs35/share total cash dividend. The earnings of the company have been fuelled on the back of higher petroleum prices and increase in demand for various oil products.

Petroleum demand in the country during FY05 depicts a 10% growth driven by both higher black oil and white oil sales. Fuel oil demand jumped by approx. 25% resulting from higher thermal electricity generation. Taking a look at white oil, HSD, MoGas and aviation fuel sales during FY05 were respectively up approx. 4%, 6% and 15%, respectively. Increased industrial and agricultural activity and consistent growth in automobiles have been primary contributors. On the other hand, Kerosene and LDO sales were down approx. 10% and 15%, respectively. During FY06 the prevailing high oil price levels may result in an overall slowdown in the growth pace of the demand for petroleum products.

For FY2005-06, the government has budgeted Rs15.9bn Petroleum Development Levy (PDL), portraying 47% increase compared to the Rs10.8bn revised estimate for FY05. The budget deficit target for FY06 has been set at 3.8%, nearly 0.6pps higher compared to the previous year. This indicates that in the prevailing fiscal the government has limited leeway to absorb the upsurge of oil prices on the international front. Already effective July 01, 2005, the government has raised domestic petroleum prices by up to 9.2%. Global crude prices have attained record levels, hovering around the US$60/bbl level on the back of severe global demand-supply imbalances. If this high oil price trend persists the government will have to continue raising petroleum prices on the domestic front, bodes positively for the OMCs in the form of inventory gains and higher rupee margins.


Pakistan State Oil (PSO) approved a cash dividend of Rs 10/- per share (100%) for its shareholders. Combined with the earlier interim dividends, the total dividend for the financial year came to 260%.

The dividend declared during the preceding year was 175%. The Board observed that the company sales revenue during the period under review stood at Rs 254 billion, up by 30% over last year. As a result, profit after tax was an all-time record of Rs 5.7 billion, up by 35% from preceding year. The performance was due to increase in sales volume, international prices and innovative products and services.

During FY05, Pakistan's economic recovery experienced greater momentum with a real GDP growth of 8.4%. With the economy expanding at its fastest pace in the last two decades, an encouraging trend for the future is anticipated.

The consumption of POL grew by 10% over the previous year, owing to an increase of 5.5% in White Oil and 21.1% in Black Oil. In White Oil, the upward movement was brought about by an increase in consumption of Mogas, HSD and JP-1 to the tune of 5.3%, 5.5% and 12.4%, respectively. In Black Oil, FO consumption went up by 23.3%, because of low availability of water and disruption in supply of natural gas.

In FY05, PSO achieved a market share of 58.3% in White Oil. The Mogas volumes grew by 7.5%, thus increasing the market share from 43.8% to 44.7%. In HSD, despite stiff competition by existing and new entrants, PSO's volume rose by 4.3% and the company's market share stood at 59.8%. Similarly, JP-1 and SKO were at 63.1% and 69.8%, respectively. In Black Oil, the company sales gained 30.7% over last year attaining a market share of 79.2%.

The company successfully implemented its ERP initiative (SAP) that went online from July 1, 2005, at all the installations, depots and marketing offices. With SAP in place, the company is favorably positioned to provide better quality service to its customers and other stakeholders. The Board observed that competition has intensified and new players, with limited infrastructure investments, are impacting the level playing field for established OMCs. However, the strength of an established infrastructure, investments in improvement of systems for greater efficiency, and the efforts to innovate and excel in customer service will continue to assert PSO's market leadership in future. The FY05 results are a testimony to this resolve. The Board appreciated the teamwork demonstrated by the employees, which has generated strong vibes for rapid progress of the company and overall prosperity of all its stakeholders.