Oil refineries' pricing formula

Pakistan's oil refineries have urged the government to replace the current ex-refinery formula, based on deemed duty with a guaranteed return formula in an effort to save the industry. There is evidence that oil refineries in the country are facing closure. To evaluate their proposal, it is critical to evaluate the formula applicable in the past.
The pricing formula first followed was to extend 17 percent guaranteed return over and above the operational cost of the refineries. As the guaranteed return was not placed in a separate escrow account therefore there was a distinct possibility of abuse; and there is adequate evidence with the government that there was considerable abuse.
The Shaukat Aziz government decided to link the price with the international price of oil. In addition, it agreed to 10 percent deemed duty for those refineries that established sulphurisation plants in an effort to combat pollution. Unfortunately, few of the oil refineries set up sulphurisation plants with the exception of the largest refinery, with state involvement notably PARCO, though all materially benefited from deemed duty.
It is little wonder then that the government has reduced the deemed duty from 10 percent to 7.5 percent - a source of major concern for the oil refineries. And this has led to their request to the government to return to the earlier system of guaranteed return as opposed to the deemed duty. However, Business Recorder strongly urges the government to keep in mind one major principle for extending subsidies: they must be targeted to the consumer and not to the shareholder.
A guaranteed return is tantamount to extending a subsidy to the shareholder. Be that as it may, there is evidence that the oil refineries are in serious financial trouble. One reason is the circular debt. PSO owes around 55.429 billion rupees to oil refineries; its inability to pay is premised on the fact that PSO is owed a huge amount by the Discos as well as the privately-operated KESC.
The distribution companies are continuing to struggle to receive their arrears from government departments as well as ministries. The line losses too reflect inefficiency, though they vary from disco to disco. The issue of circular debt has held the country's energy sector hostage for the past year and a half and needs to be resolved urgently.
The government, in line with its commitment to the International Monetary Fund under the Stand-By Arrangement, not only acknowledged the problem of circular debt but also committed to resolving it. Term Finance Certificates were issued in an effort to resolve this debt, however it has crept up again and is on the rise.
It is therefore imperative for the government to deal with this issue once and for all. There are many in government circles who are proposing shutting down the refineries on the basis that they maybe able to procure refined oil at cheaper rates from abroad.
While it is true that the operating costs of our refineries are higher as they are small and therefore unable to take advantage of the economies of scale, yet shutting them down is not advisable as it would mean importing the higher value addition refined oil which would have repercussions on our foreign exchange reserves. It is therefore hoped that the government takes appropriate measures to ensure the elimination of circular debt as well as keeps the principle in mind that subsidy must be extended to the consumers and not the shareholders.