Corona and the energy sector

The government continues to be in search of a way out for reducing or arresting the projected increase in gas and electricity tariff. I have also been arguing the need for cheaper LPG rates, at least for the poor. In this space, we will discuss the prospects and impact of falling oil prices on Pakistan’s energy sector – on both producers and consumers.

Oil prices had already come down much before Corona. Initially, there was an oil price war between the two major oil producers – Saudi Arabia and Russia – and then came Corona’s impact of lowering demand and consumption. Pakistan’s lower economic growth projections at three percent also had a depressing impact. It is projected that there would be a demand reduction of at least 35 percent over the year.

There are projections of oil prices coming down as much as $10/bbl. This would be a destructive price, having a negative impact on the sector and the world economy. The average sustainable production costs and prices are quoted at $40/bbl.

Generally, oil prices have had a salutary effect on Pakistan’s economy and welfare conditions. The government has announced a decrease of Rs15 per litre. More reduction is projected, if the fall in prices continues. Some people argue that more reduction was possible even at today’s prices. However, the government needs revenue. Its revenue will come down with the economic downturn and it has to finance the emergency package, as it has announced a relief package and other incentive packages.

Throughout the month of March, Indian prices remained almost constant. In fact, the Indian government announced an increase in excise tax on petrol and diesel by 8 IRs (PKR16) per liter. They will lower prices eventually but the Indian government has already announced to shave off IRs8 out of the projected decrease in oil prices. We have mentioned in an earlier piece that oil prices in Pakistan are lower than in India.

With oil prices, gas prices have come down as well, although LNG prices are based on the last three months oil prices slowing down the reduction rate. Qatar LNG landed price hovered around $10/MMBtu, which is expected to come down to a level of $4, although spot LNG prices have already come down to less than $4. On the other hand, overhead costs of LNG have already increased due to underutilization.

In February, one LNG ship landed at Pakistan Gas Port Limited (PGPL) terminal as opposed to a normal of six ships. As a consequence, the LNG tariff at that terminal has increased to $2.2895 as opposed to the normal terminal tariff of $0.42. Earlier gas shortages were being projected and there was an upbeat demand for new LNG terminals. This has already lost its shine and enthusiasm. It would give more time to the government to sort out its policy options.

Electricity demand may also go down by 25-30 percent if the economic downturn and Corona impact continues. Winter is gone with traditional low demand as low as 50 percent of the summer demand. Gas prices will reduce the cost of production. It is not yet clear if coal prices will come down appreciably. Gas based electricity prices may go down by 25 percent. Due to decrease in demand, fixed charges would increase, thus almost nullifying the effect of decrease in fuel prices.

There would be problems for the local oil industry. Some local refineries have already shut down their units. Furnace oil may come up again due to its lower price competing with gas. There was no lifting of furnace oil by the power sector in the recent months. It has now already started lifting furnace oil. However, the E&P sector would come under pressure as are all oil companies throughout the world.

The two major bread earners are OGDCL and PPL, with significant government ownership. Last year, OGDCL made a profit of Rs118 billion and paid taxes of estimated Rs40 billion at average oil prices of $60-65/bb. Similarly, PPL generated net profit of Rs61.6 billion and paid taxes to the tune of Rs23 billion. These two companies and others may go in loss depriving the government of a total corporate taxation and other revenue of around Rs250 billion in addition to employment taxes. The government may have to make changes to the current crude pricing formula which is based on landed costs of Brent Crude prices. Local production cost is estimated at around $30/bbl.

If oil prices go down below this level, the government may have to introduce floor prices and to balance it, price ceilings may also have to be introduced. Fortunately, the oil and non-oil income of the two companies has averaged at 45 percent of the total revenue. Gas prices have a floor and ceiling formula reducing the impact of downfall in oil prices.

There have been imports of around 18-20 million tons per year valued at $12-13 billion. Imports may come down by 30 percent, although it would be the beginning of the last quarter by the coming month. Yearly impact at reduced oil prices at $30/bbl on average may cause a reduction in oil import bill of $7-8 billion – ie the oil import bill may come down to $4-5 billion only, something which has not occurred in the recent history. There may be an additional one billion USD of lesser LNG imports.

Concluding, overall the impact of low oil prices on Pakistan’s economy would be positive, although there may be some risks of reduction in remittance income and loss of revenue and profits in the domestic oil industry. This may give some space to the government to arrest inflation and offer welfare-oriented consumer tariff for energy items other than oil. While the corona effect may last beyond one year, oil prices may eventually recover partially after touching a new low which has yet to come.

The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy Issues:Success and Challenges’.

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