Sectoral policies: start with deregulation

The government is in the process of developing policies for selected sectors such as refineries and automobiles. Having well defined policies in any sector is the right approach to give right signal to investors, allowing government to seek investment in desired areas. However, policy formulation is becoming weak in Pakistan, as modus operandi is extremely ad-hoc. Discussions take place with industry players who present their wish-list, which is then tweaked a little bit. And out comes the policy.

That is not the right approach. Government’s intentions may be well placed, but the execution is weak. It is required to engage independent consultants to evaluate sectoral dynamics and prescribe policy measures. In many instances, bureaucracy and business bodies even fail to come up with a decent Term of Reference (ToR). Yet, they are formulating policies for billions of dollars of investment. If a policy is made in the right manner, it yields dividends. For example, during the Musharraf era, the government engaged international consultants and came up with a framework to deregulate the telecom sector which led to a revolution in the industry.

Obviously, industry players have vested interests, thus the government must not rely solely on them. Experts too come and go in the form of SAPMs and advisers to PM. And in many instances, they have conflict of interests. The debate on media is usually shallow, but these have an impact on decision makers. Ministers are influenced by media and hearsay from their friends in the industry. There is no coherent approach.

For example, in the auto policy, the government is supporting local assembly by incentivizing Completely Knocked Down (CKD) imports. But Semi Knocked Down (SKD) import is not incentivized at all. Both the cases have their own merits and demerits. In case of CKD, auto assemblers/manufacturers build assembling lines, press shops, paint shops, etc., and all the machinery is imported and most of the raw material is imported, and the car is produced specifically for domestic use. In case of SKD, the assembler imports shell body, and can assemble even without paint and press shops. This approach can take Pakistan to exporting automobiles by adding certain value.

The role of the government should not favor one specific model but to promote local production of vehicles. It should have rules and regulations on the specs and safety of vehicles, but not the assembling method. Leave the decision to adopt a certain method to the investors. However, CKD assembly is the norm among existing players, these present themselves as stakeholders’ in consultations with the government, and the SKD option is never considered seriously.

The other hot sector in debate lately is oil refinery. A policy document was prepared by Nadeem Baber (when he was SAPM petroleum) in consultation with existing industry players. The policy envisages billions of dollars of investment and incentives are being offered (to be charged from consumers) based on certain type of expansion. It is written in the policy that no hydro-skimming new refinery is allowed, and the refinery must be deep conversion. That is the wrong approach. The government must define certain quality and specs of petroleum products- for petrol, diesel, and others, which shall be produced locally. Whatever equipment and method the investor deploys is his(er) choice.

For example, hydro-skimming is fine for processing light crude, while deep conversion is more suited for heavy crude. Light crude is expensive, but hydro-skimming plant is cheaper. On the other hand, heavy crude is cheap, but deep conversion technology is expensive. It’s a question of economics. In one case, there is high capital (fixed) cost while in other, the raw material (marginal) cost is high. Let the investor make the decision. By not allowing hydro-skimming, the government may lose the potential of light crude and condensate produced in KP. One option could be to have topper (hydro-skimming) small refinery on-site and for further processing, products can be sent to a bigger refinery. Let the investors do the math.

Some argue that fuel oil (furnace oil) is produced in the old methodology, and its demand is falling. Yes, that is correct. But it’s a headache for investor to find avenues to sell off FO. Back in the day, when refineries were first built in Pakistan, FO was hot cake and hydro-skimming suited all as FO produced was residual. Now after the IMO 2020, international demand has tanked, and local demand is falling too with RLNG and coal power plants coming online. If any refinery in Pakistan – with or without expansion – does not deal with further processing of FO to other products, it will die. Let the investor handle the commercial issue.

Then there were arguments on the issue that a certain refinery is importing old plant, and whether the government should offer incentives for bringing old plants. Again, it is not government’s concern to decide which equipment type any refinery may use. The government needs to define control mechanisms and product specifications. If someone is using old refinery to do so, let them.

The government needs to realize that capital expenditure on any new refinery is too high. There are talks of having one big refinery in Pakistan by foreign investors for two decades – yet no real development has materialized. The return on investment could be as high as 20-25 years for breakeven. The way world is moving towards EVs and hydrogen fuel vehicles, the demand for road fuel — petrol and diesel — may fall. Let the investor decide on the future course. The government should be happy if environmental and other standards are met.

The other question is on what basis government is making Euro-V fuel the only option. Have studies been conducted on the kind of vehicles on road, and the fuel type needed to control air quality? What kind of pollutants to control and how? What are the vehicle exhaust specification, and based on those what kind of fuel is environmentally and economically efficient? The automobile specifications and fuel options for refineries go hand in hand. They cannot be divorced. And simply copy-pasting European standards may not cut right.

Almost half of country’s petroleum consumption is for motorbikes. Does spending top dollar on Euro-V for these basic bikes make sense? In Europe, there are specifications for exhaust and having high Sulphur content can damage catalysts in the exhaust which kills other pollutants. Otherwise, sulphur dioxide itself remain high in the air, not causing breathing problems. Then the country is importing Euro-V and local refineries are using Euro-II standards. The question is what will be the efficacy of Euro-V if Euro-II is passing through same pipelines and tankers.

One should not copy- paste without understanding ground realities. That is why before finalizing the refinery policy, some international consultants should be engaged to offer specifications and timelines. Then based on these, incentive structures should be given.

The government must think of deregulating the industry. If the government is not doing any study, it must deregulate the industry and let the refineries compete with the imported product. The government only defines specifications and timelines on the products. It needs to think on the import duty cover for refineries – proposed at 10 percent for petrol and diesel and let the sector make its move. The case in automobile is similar where there is duty protection for local assembling from imported units. Do the same for refineries.

The government must move towards ending the regulated petroleum prices. It should end the IFEM (inland freight equalization margin). Let the refineries compete openly. As was the case of telecom and banking, deregulation in oil refining and marketing sectors would most likely bring efficiencies and prices may move down. However, the government would lose the control on pricing. And by keeping the control, the policymaking becomes complex and some fear that market players may exploit consumers. The government needs to learn that if markets are efficient than the government and consumer would be happy to have the sector deregulated.

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