INCREASE IN OIL AND GAS PRICES

Shockwaves received in all corners of the country

By AMANULLAH BASHAR
May 08 - May 14, 2006

Effective May 01, 2006, the Oil and Gas Regulatory Authority (OGRA) has made an across-the-board increase in domestic petroleum prices, ranging between 2.5-7.2%.

This is for the first time during the current calendar year that prices have been raised however move has sent a wave of resentment from grass root level to trade & industry, political pressure groups as well as in the National Assembly.

The notice has also been taken at the highest level of the judiciary which has asked the relevant authorities to justify the increase in oil prices which are already stated to have a back breaking effect on the economics of average income groups.

Despite the fact that the recent increase in oil prices was generally anticipated on the back of the massive spiraling on the international front, yet the question is being raised at all forums that within the given income level in Pakistan can people afford to buy things at international prices. If the economic managers have decided to tie up prices with international market they should also consider the wages and income of the common man to bring at par with the international level of.

Dilating upon the situation after increase in oil prices, Abdul Sami Khan, Chairman Pakistan Petroleum Dealers Association said in an interview that price inflation has reached a point where things should be looked from humanitarian grounds.

The oil price issue has not hit the people of Pakistan alone but its shock waves are equally being felt even in the developed economies as well. Citing the example of France, Sami observed that in order to protect the price mechanism as well as the people of average income group, the government in France has decided to reduce taxes on petroleum products to keep prices intact.

Now is the time that the government in Pakistan should also reduce its levies and tax on petroleum products to protect common man as well as in the larger interest of the economy. If the oil related price inflation was left untamed it is feared to wash off the economic gains besides erupting social problems in this country.

While fixing petrol prices, the people at the helm of affairs should keep in mind that the entire petrol consumed is produced indigenously hence it saves the freight cost spent on other petroleum products. Hence the petroleum should be given a relief both on account of domestic product and freight cost.

However, the magnitude of the price hike was fairly lower than general expectations if compared to the rocketing international oil prices.

In the latest fortnightly review, the prices of Mogas, 2.5%, 3.4%, 4.2% and 5.2% has raised HOBC, HSD and LDO respectively.

The price of Kerosene Oil has also depicted 7.2% surge to Rs35.23/litre compared to Rs32.87/litre previously. Furthermore, the government has communicated that it has absorbed a burden at Rs2billion and passed on an equivalent burden to the consumer. Moreover, the government has had so far suffered a revenue loss at Rs66billion since May 2004.

The government has also claimed that it was providing a subsidy at Rs8.94/litre on Kerosene, Rs8.06/litre on LDO and Rs4.43/litre on HDO.

The unprecedented hike in international oil prices during the last two months is the major factor behind the increase in domestic POL prices.

New York crude futures seem to have consolidated above the US$70/bbl on increasing tensions between the US and Iran as well as the broader global demand-supply imbalances. In the medium-term, prices may tread higher on political instability prevailing in major oil exporting countries (Iran, Iraq and Nigeria).

In recent months, inflation has slowed down on the impact of lower food prices. Nonetheless, CPI in the coming months may once again depict an ascending trend due to this recent increase in domestic POL prices. Oil inflation has a chain effect on most economic sub-sectors as it effectively raises the aggregate cost of industrial production. Inventory gains for OMCs. An increase in oil prices is generally positive for the OMC's in the form of inventory gains and higher rupee margins. OMC's earnings during the last few quarters were lackluster on squeeze in margins as well as the descending demand trend. However, sentiment towards the scrips may improve following the recent price hike.

The oil marketing companies are believed to have made fortunes on the back of price increase both in terms of their stocks value in the capital market as well as huge gains on their inventory advantages.

PSO announced its financial results for the first nine months of FY06 on April 27, 2006. Earnings of the company stood at Rs4, 588million reflected in their earnings per share (EPS) which was estimated at Rs26.75 as against Rs4, 304million (EPS: Rs25.10) previously.

Third interim dividend payout at Rs5.00/share accompanied the results, taking the cumulative payout for FY06 to Rs16.00/share.

Net Sales of the company increased by 31% to Rs199, 619million on the back of better product mix and marketing strategy. Gross margins of the company declined by 70 basis points to 5.4% as against 6.1% previously.

Financial cost too depicted a surge at 131% to Rs564million compared to Rs244m previously. During the period ended March 2006, sales volume of the industry declined by 7% to 10.6million tons

The conversion of automobiles to CNG, lower seasonal demand of HSD and availability of hydel energy to power plants are however some of the reasons for the decline in sales volumes.

GAS

Meanwhile, the bulk gas consumers especially the industrial consumers have raised a strong voice of protest after the increase in gas prices. The prices were increased following the pursuit of the gas companies which had originally filed a petition on 30-11-2005 for "Estimated Revenue Requirement for FY 2006-07" in order "to earn 17% return on average net fixed assets in accordance with the requirement of Asian Development Bank's Loan Covenants and as per licence condition No. 5.2" demanding an upward revision by Rs.4.04/MMBTU.

An Amended Petition was filed on 24-03-2006 "to meet the shortfall in Company's Revenues mainly due to increase in cost of gas and earn 17% return on net fixed assets...."Demanding an increase of Rs.29.36/MMBTU. This morning we found that they had filed yesterday (17-4-06) yet another petition asking for further rise of Rs.2.16/MMBTU. So the total increase petitioned is for Rs. 31.52.

The Petitioner has raised two issues in its Estimated Revenue Requirement for FY 2006-7:

17% Return on average net fixed assets.
Increase in cost of gas (gas wellhead price).

The Asian Development Bank's Covenant of 17% return on average net fixed assets has expired on 31-12-05 and the loans have also been paid off. Then why does the Petitioner refer to the Covenant? Reference to it only creates suspicions and doubts.

The issue of 17% return on average net assets has been debated and discussed, vociferously at times, in every hearing that this Authority has conducted in the last couple of years. In the last hearing held on December 18, 2005, we were told by the Authority that the evaluation of the current tariff regime is under study and a proposal is under review of the Federal Government and other stakeholders. This is also recorded in the OGRA Decision of December 31, 2005. So many months have passed and yet we continue to debate its validity and efficacy. Decisions taken expeditiously save many misunderstandings and its repercussions.

The fixed 17% return is providing the Gas Company to function in a protected environment especially so when the return is on average net fixed assets and not weighted average. In order to achieve maximum guaranteed return (MRG), all that the Petitioner has to do is to maximize its assets. The following statistics give a fair picture of the leeway the sacrosanct figure of 17% MRG gives to the petitioner:

Increase in gas sales (MMBTU):
338,945-360,741=21,796 (6.43%)
Increase in T&D cost (Rs.):
4073.439-5153.405=1,079.966 (26.51%)
Increase in Net Assets (Rs.):
(2005-06): 22,963 - 20,500.056 = 2,462.944 (12.014%)
(2006-07) 32,009.701-23,171.439=8,838.262 (38.143%)

These figures need no explanation or critical analysis. They speak loud and clear and expose the underlying intents.

It is an irony that the "under privileged class" of the society, the highest contributor to the economy, has to bear the primary cost of gas as well as the 17% return on behalf of the "Privileged class". In the instant Review Petition, the cost of gas alone, as shown by the Petitioner, is Rs.209.44 whereas suggested price for supply of gas for feedstock to the fertilizer company is Rs.36.77, only 17.55% of the cost of gas. And they don't have to worry about the other 17% either! This is truly ridiculous and totally unjust and unfair that a particular sector is subsidized so heavily and that too at the cost of the other sectors of industry. We reiterate that if the Government wishes to pamper these blue-eyed babies, they may happily do so but at its cost and not at the cost of other industries.

The fertilizer industries, for their feedstock production, are supplied gas at dirt-cheap price to pass on the benefits to the growers/agriculturists. But what is the factual position? I have with me here the Annual Report 2005 of Engro Chemicals Pakistan Ltd. It makes an interesting reading.

On a sale of Rs.18.276 billion, Profit after tax is Rs.2.319 billion (12.7%)
Earning per share (of Rs.10) - Basic & Diluted, Rs.15.16
Dividend per share of Rs.10: Rs.11.
Net Assets per share: Rs.48.23.

Engro gets gas at Rs.82.06 per MMBTU for its feedstock production with the above financial results. No wonder then that it has its fingers in multiple businesses like Joint venture with a Dutch Company, Engro Vopak Terminal Limited, Engro Asahi Polymer & Chemical Ltd. with the Japanese Co., Innovative Automation & Engineering, trading house, Engro Eximp, Engro Energy and recently Engro Foods, dealing in dairy products was launched. Recently Engro announced a 10% increase in its price of urea, other manufacturers have followed suit. Reason they have put forward? Surprise, surprise, and Increase in gas prices!

We fail to understand why doesn't the single fertilizer company that SSGCL is supplying gas at Rs.36.77 not doing as well? Over pampering and over protection is bound to have its own direction and results.

The Lower Level Targets of Unaccounted For Gas (UFG) were 5.7% for 2005-06 and 5.4% for 2006-07. The Petitioner has not been able to meet these targets and has, therefore, opted for penalty. This raises two pertinent questions:

At whose expense? Obviously the shareholders are being deprived of the amount.

Is it morally and ethically correct? It's like a car driver who drives through a red traffic signal and goes scot-free by paying the penalty at the other end.

Gas is a prime mover of Pakistan's economy. It is therefore imperative that its use, allocation and prices should be managed with great care, expertise and broad vision. The formula of indexing prices of gas to crude oil and furnace oil is based on the theoretical concept of opportunity cost. Simply put, it means that if Pakistan were not to produce gas, then it would have to import oil as its substitute. But the fact is, PAKISTAN IS PRODUCING GAS INDIGENOUSLY. This is its natural resource, for the benefit and convenience of its people. The Managing Director of SSGCL gave the examples of Japan and Korea using imported gas at much higher prices. How we wish we were Japan or Korea. Their technological advancement, their economy of scale and their economy of production are all enviable. We can compare our selves only to our neighbors who are in the same league and not with those in the super league.

This is how other nations with natural resources see them.

Saudi Arabia with the largest oil reserves in the world (all explored by non-Saudis) supplies oil to its local consumers at less than one fifth the international price.

In Iran the price is less than one tenth and more surprisingly, the price of gasoline has not changed since the Revolution in 1979!

In Holland, gas is produced locally and sold cheaper than the imported oil. What is more practical is that the domestic gas-oil parity does not correspond to international parity.

Last but not the least is the fact that the rate at which Bangladesh sells gas to its industries is about 35-40% cheaper than our rates to the industry. The industries in Bangladesh are not required to subsidize another industry. The Government pays for the subsidies from its own coffers.

It is interesting to note that the state-owned companies, OGDC and PPL, produce 45% of the gas while Australian, Italian, British, etc companies supply the balance. Of the total 40 to 50 gas wells that are drilled every year, half of them are by the public sector, OGDC and PPL.

Quadirpur gas field belongs to OGDC. Quadirpur gas field is the largest supplier of gas to SNGPL. The determination of gas wellhead price from this gas well is computed under a formula. According to the Agreement with the GoP, when average price of HSFO of six months exceeds US$200 per ton, the discount will be frozen at 45% and the Agreement says the parties are to renegotiate discount within 6 months. The average C&F price of HSFO was US$206.7668/ton for the period July-December 2005 for which the Gas price was computed at US$2.5618/MMBTU. For the period Jan-June 2006, the average C&F price of HSFO was US$282.2770/ton and the gas price calculated at US$2.5618! We fail to understand why the government has not re-negotiated as per the clause of the agreement. Does it not understand the gravity of the situation? It's indifference and irresponsible attitude will wreak havoc on the industry in general and the exports in particular. If the government does not act now, the damage will be irreparable. Exports of US$17 or 18 billion will only be pipe dreams!

Another gas field that needs the attention of the Government is KANDAWARI. As per Agreement signed with the Government by the owners of the gas well, no ceiling or floor was specified on average C&F price of HSFO after five years of operation. The result is before you, Members of this august body; this gas field is supplying gas at the rate of gasoline! The price specified is US$4.8154/MMBTU during July to December 2005 and US$6.5728/MMBTU during January-June 2006.

Let us examine if our economy has the resilience to absorb any more increase in gas prices:

It is a universal truth that the electric charges in Pakistan are the highest in Asia. Any increase in gas prices is bound to further spiral the power rates as KESC is also using gas for its major generation.

It is also a universal truth that the exports of Pakistan are hugely dependent upon textiles. The cost of production in Pakistan is already higher by 19% compared to our competitors in the region, India, China, Sri Lanka, Bangladesh and even Vietnam. Bangladesh and Sri Lanka are non-cotton-growing countries yet their textile exports are rising because they enjoy the GSP plus facility from the EU. In sharp contrast to Pakistan, they are classified as Least Developed Countries (LDCs) and thus enjoy tariff exemptions and concessions.

Our production of raw cotton is around 14 million bales. This year there is a possibility of 13% fall in production. One bale of raw cotton can fetch US$119 and the same bale, if exported as value-added product, can fetch US$1594 in the international market.

Our Government has targeted exports of US$17 billion (President Musharraf thinks of $18billion.).

The first quarter report of State Bank of Pakistan has highlighted an increase of 28% to US$40 billion in exports of textiles. That was for July-October 2005. The second and third quarter reports will have a different picture altogether. Our knitting industry, which contributed substantially to textile exports, about US$1.2 billion, in the last many years, is more or less closed.

Foreign investment in Textiles, the most vibrant sector of the country, is totally absent. The US$5 billion investment in textiles to meet the challenges of WTO belongs to Pakistanis and no one else.

Sindh is likely to have 1 to 1.5 million jobless people each year as nearly 60,000 are annually added to the job pool. In FY 2004-05, 61,000 were jobless. The poverty level is 32% and if you take away Karachi, it becomes 48%, which is abominably high.

With this economic scene prevailing in the country, it is obvious we cannot afford another hike in gas prices. Our economic managers have to devise a plan to bring down our cost of doing business and not add to it. Our infrastructure is in shambles; Social Compliances under WTO are now stringent, Cleaner Production and Effluent treatment are the requirements of the day. The people in power are fully aware of the fact that gas has the importance of a raw material in textile industry, the highest employer of human resource and the biggest foreign exchange earner for the country.

We believe subsidy must be done away with, totally and completely, if the industry is to survive and especially the Textile industry. If the Government feels like subsidizing, then it must do so from its resources like GDS and Excise Duty on gas wellhead. It must also be remembered that no industry, worth its name, can survive on crutches, in this modern age and concept of global village.

Furthermore, we believe that a lot of work has to be done on pricing of gas from wellheads. Gas is our natural resource and it must be utilized our survival, progress and prosperity. It is OURS and we have the right to its benefits. The agreements with the gas producers, Qadirpur and Kandawari in particular, must be re-negotiated in a transparent manner. The absolute freedom of pricing granted in case of Kandawari who is selling gas at Rs.457.43/MMBTU, is atrocious, to say the least. This is a glaring example of complete absence of transparency and accountability. The Government can still correct the wrong that has been done by whoever was responsible.

The Government must move swiftly and decisively in resolving the gas wellhead prices and keeping them within affordable limits. This is the need of the hour.

OIL

Poten-
tial

Discove-
ries

Pro-
duced

Refinery Capacity 2004-05

Crude oil production 2004-05

Import Crude oil 2004-05

Wells Oil & Gas

Sectoral Oil Consumption 2004-05

27 billion barrels

844
Million barrels

535
Million barrels

12.82 Million tones / year

535 Million 
barrel

8.3
Million tones

620
Explored
177
Discovered

Power 23.5%
Transport 61.5%
Agriculture1.0%
Industry 10.5%
Domestic 1.3%
Government2.2%

Source* Ministry of Petroleum Government of Pakistan.