Addressing gas sector circular debt: causes and solutions

The gas sector in Pakistan, which was relatively stable until 2013, has since faced the substantial challenge of circular debt. Understanding the reasons behind this accumulation and devising strategies to mitigate it is crucial for the sector’s stability and growth.

Understanding gas sector circular debt

Circular debt in the gas sector can be understood through a simple equation: the total cost of delivering gas should equal the wellhead price of gas plus transmission and distribution losses, plus the Sui companies’ margin (17.2% return on assets), and Unaccounted for Gas (UfG), which includes theft and leakages.

For Sui companies, the total revenue comprises bills collected and subsidies paid by the government. When the cost of gas delivery goes up due to any of the above factors without a matching increase in revenue, the differential accumulates as payables, forming what is known as gas sector circular debt.

This debt is parked on the balance sheets of upstream exploration and production companies like Oil & Gas Development Company Limited (OGDCL) and Pakistan Petroleum Limited (PPL), which provide gas to Sui distribution companies but do not receive payments. Similarly, Pakistan State Oil (PSO) procures Regasified Liquefied Natural Gas (RLNG) from Qatar under long-term agreements but fails to receive corresponding revenues from Sui distribution companies. This scenario inflates PSO’s receivables, undermining its capacity to grow, expand, and meet obligations to foreign suppliers of RLNG.

The build-up of gas sector circular debt post-2013

The accumulation of circular debt in Pakistan’s gas sector after 2013 can be attributed to two primary factors:

1. No Gas Price Increase (2013-2017). During this period, gas prices were not allowed to increase despite rising production costs. This led to unfunded subsidies as the revenue from gas sales was insufficient to cover the growing costs.

2. Introduction of LNG as Petrol. Liquefied Natural Gas (LNG) was classified as petrol instead of being included in the gas basket to determine a weighted average cost of gas. This decision resulted in a structural inability to fully recover the cost of RLNG, which is four times more expensive than locally produced gas when diverted to residential and industrial consumers.

The inability to adjust gas prices in line with increasing production costs and the misclassification of LNG led to significant financial imbalances. These imbalances were exacerbated by the lack of a structured method to recover the full cost of RLNG, contributing to the accumulation of circular debt.

In February 2022, the parliament passed a law to allow for a Weighted Average Cost of Gas (WACOG). This law was designed to address the pricing disparity by ensuring that the cost of gas, including RLNG, is reflected in the price charged to consumers. However, more than two and a half years later, the law has yet to be implemented, perpetuating the cycle of gas sector circular debt.

Strategies to address gas sector circular debt

To effectively tackle the gas sector circular debt and associated issues, the following steps are imperative:

1. Fully Implement the WACOG Law: Enforcing this law will ensure a balanced pricing mechanism that reflects the true cost of gas, including RLNG. Implementing WACOG would mean that the higher cost of imported LNG would be averaged with the lower cost of locally produced gas, resulting in a fairer price for consumers and reducing the financial strain on gas distribution companies.

2. Eliminate Cross Subsidies to the Fertilizer Sector: Cross subsidies distort market dynamics and create financial imbalances. By eliminating heavy cross subsidies to the fertilizer sector, the government can reduce the financial burden on the gas sector. Instead, targeted subsidies can be provided directly to farmers if necessary, ensuring that the support reaches those who need it most without distorting the gas market.

3. Remove Cross Subsidy Burden from Industry: Similar to the fertilizer sector, industrial consumers often cross subsidize the domestic consumers distorting the pricing regime in the gas sector. Removing this cross-subsidy burden would allow gas to be diverted to more productive sectors, optimizing its use for economic growth and reducing the financial strain on gas distribution companies.

4. Promote the Use of LPG: Liquefied Petroleum Gas (LPG) can serve as an alternative to natural gas, particularly in domestic consumption. By ceasing new gas connections and encouraging LPG usage, the government can reduce the strain on the gas distribution network. Promoting LPG would also help diversify energy sources and enhance energy security.

5. Restructure the Gas Distribution Business: The gas distribution business in Pakistan is currently monopolized by two Sui companies. Separating the distribution business from the sales business would allow private sector entities to use the Sui companies’ transmission and distribution networks at affordable rates. This restructuring would foster competition, improve efficiency, and attract private investment, leading to a more dynamic and resilient gas sector.

6. Offer Better Rates to Local E&P Companies: Local exploration and production (E&P) companies play a crucial role in the gas sector. Currently, there is a significant disparity between the rates paid for imported RLNG and locally produced gas. If imported RLNG is bought at $11 per mmbtu, local companies should be offered competitive rates, such as $7-8 per mmbtu. Offering better rates to local E&P companies would incentivize domestic production, reduce reliance on imported LNG, and enhance energy security.

7. Develop Gas Storage Facilities: Gas storage facilities are essential for buffering against price volatility and ensuring a stable supply. Developing such facilities would enable Pakistan to store excess gas during periods of low demand and release it during peak demand, stabilizing prices and ensuring a consistent supply. Gas storage facilities would also enhance energy security by providing a strategic reserve in case of supply disruptions.

   The accumulation of circular debt in Pakistan’s gas sector is a complex issue that requires a multifaceted approach to resolve. By fully implementing the WACOG law, eliminating cross subsidies, promoting the use of LPG, restructuring the gas distribution business, offering better rates to local E&P companies, and developing gas storage facilities, Pakistan can effectively address the root causes of circular debt.

These measures will not only help in controlling and eventually eliminating gas sector circular debt but also promote a more sustainable, efficient, and resilient gas sector.

Implementing these strategies requires strong political will, regulatory reforms, and collaboration between the public and private sectors. However, the long-term benefits of a stable and thriving gas sector far outweigh the challenges, making it a critical priority for Pakistan’s energy security and economic growth.

Copyright Business Recorder, 2024