The country's five big oil refineries have reportedly lowered their crude refining output, generating serious concern among official circles that this may ultimately force the government to resort to higher oil imports, meaning thereby a further increase in the country's import bill.
According to government estimate, the current refining capacity stands at around 11.69 million tons against a demand of around 18.29 million tons, as a result of which the government has to import two major deficit products - high speed diesel and fuel oil. Refiners feel that not only has the reversal of the refining policy of deemed duty jeopardised the viability of their investment, it poses a serious threat to future investment prospects.
The immediate financial crunch faced by them is a result of mounting circular debt and negative margins. It is feared that this could lead to the closure of the existing refineries on account of accumulated losses. The deemed duty was reduced in July 2008 when the global oil prices had touched $147 a barrel. Since then the refineries have been pressing the government to increase the rate of deemed duty, as they have had to sustain losses due to a cut in the duty.
A sub-committee, constituted by ECC of the Cabinet, has, in the meanwhile, agreed in principle to a raise in deemed duty to 10 percent from 7.5 percent, putting the upper cap at $70 a barrel. According to sources quoted in our report, the Ministry of Petroleum has directed the refineries to ensure 100 percent operational efficiency in order to reduce the need for increased POL imports.
The refiners, on the other hand, have argued that they are not in a position to place crude oil import orders because of the liquidity crunch they are facing. Oil refineries are one of our strategic assets - whether privately owned or government managed. They are a key support structure that ensures a continuous and uninterrupted supply and storage of strategic oil reserves.
Most refineries in the country are hydro skimming refineries and they do not exploit the crude by deep-conversion, a process of conversion of hydrocarbons that could lead to more value-added products. They are also comparatively smaller in capacity and they lack any secondary processing facility when compared to similar refineries in the region. They also churn out high yield of loss-making products such as fuel oil.
This means that refinery margins in Pakistan are much lower than those in the region and major products usually have negative price differential against crude. The import parity pricing formula restricts the return on paid-up capital within a range of 10 to 40 percent. This does not allow refineries to plan out future upgradation and conversions.
Therefore, refineries were allowed to charge deemed duty on some of the products under an arrangement whereby any after tax profit above 50 percent was transferred to a "special reserve account" to offset future losses or to make investments for expansion or upgradation. At present, refineries are suffering from a profound circular debt in addition to heavy stock and foreign exchange losses.
As a result, this has eroded their margins, reserves built-up for upgradation as well as equity. In case the existing refineries close down, Pakistan will be required to import 10 separate products instead of just two or three ie crude, HSFO and HSD, in order to meet its existing petroleum products' requirements.
The country, therefore, would be at the mercy of market forces and any snag would disrupt nation's supply chain. It would therefore be advisable that existing refiners be supported and directed to upgrade and expand within a well-defined timeframe. They need to also invest in desulfurisation and other cleaner products.
Establishment of second-hand refinery should not be allowed unless they have secondary processing facility. It is also important that investors are encouraged to establish only 'deep conversion' refineries producing valuable petrochemical products. Finally, despite financial pressures refiners should avoid at all costs the "stop and go" behaviour and accept that they need to invest for the inevitable demand surge in the future.
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