Adil Khattak, Chief Executive Officer of Attock Refinery Limited since 2005 has been associated with The Attock Oil Group for the last 47 years. He has extensive experience in engineering, maintenance, human resource management, project management and marketing.

Mr. Khattak also holds Chief Executive Officer position of Attock Gen Limited, National Cleaner Production Centre, President, Attock Sahara Foundation and Chairman, Oil Companies Advisory Council (OCAC). He is on the Boards of Attock Petroleum Limited, Attock Hospital Limited, Petroleum Institute of Pakistan (PIP), Lahore University of Management Sciences (LUMS), Ghulam Ishaq Khan Institute of Engineering Sciences and Technology (GIKI) and Sustainable Development Policy Institute (SDPI).

He holds a master’s degree in engineering from Texas Tech University, USA. Following are the edited excerpts of a recent conversation BR Research had with him regarding the energy sector, particularly the downstream refining industry:

BR Research: Can you walk us through the progress of the refinery policy so far?

Adil Khattak: Work on the refinery policy for greenfield and brownfield projects started around four years ago. However, progress was hindered by a lack of political and bureaucratic continuity. To begin with, we conveyed to the government that securing the $4-5 billion investment they aimed for was impossible given the refineries’ financial struggles over the past 20 years. As a result, the government decided to explore ways to enable refineries to undertake these projects.

The policy, approved in August last year, mandates a minimum customs duty of 10% on imported petrol and diesel for seven years. Any customs duty exceeding this 10% will be reflected in the ex-refinery price and deposited into the Inland Freight Equalisation Margin pool. It includes a deemed duty of 10% on petrol and an additional 2.5% (on top of the current 7.5%) on high-speed diesel for upgrading and modernizing local refineries to produce Euro 5-compliant fuels and substantially reduce furnace oil production. Each refinery is required to sign an upgradation agreement with OGRA, depositing 2.5% of the deemed duty on diesel and 10% on petrol into an escrow account, jointly managed by OGRA and the refinery, exclusively to meet 25% of Upgrade Project cost.

Some impediments still remained. The government proposed taxing the payments from the escrow account for upgrades, which should not be the case as grants typically aren’t taxed. This would have added to the corporate tax of 29%, 10% super tax and workers’ welfare fund etc., a total tax of 44%. Another issue was that the policy stated that the 7.5% deemed duty on diesel will end in six years, which is not feasible for the sector’s survival. Competing with Middle Eastern refineries is impossible without some protection due to their sheer size, economies of scale, no income tax and negligible customs duties on imported machinery and chemicals.

The five refineries requested the continuation of the 7.5% deemed duty incentive on HSD and tax exemptions on payments from the escrow account. The government launched an audit with KPMG to verify our claims. The revised policy allowed for the continuation of the 7.5% deemed duty incentive. Initially, the policy stated that refineries would receive 25% of the project cost from the escrow account with no mention of income tax on this amount. However, the FBR argued that it couldn’t provide tax relief due to an agreement with the IMF. Eventually, it was agreed that the FBR would impose a tax, but refineries would get 27.5% of the project cost instead of 25% to compensate for the income tax.

The policy, approved in August 2023, was amended in February 2024, giving refineries a deadline of April 22 to sign the Upgrade Agreements. All refineries were ready to sign but PARCO requested more time for its feasibility study. Consequently, the Petroleum Division asked the Cabinet Committee on Energy to extend the signing deadline by six months until October 2024.

During this time, the Federal Budget FY25 was announced, proposing the withdrawal of the existing 10% customs duty on diesel imports and the exemption of sales tax on petrol, HSD, kerosene, and light diesel oil. Previously, these products were previously zero-rated, allowing input sales tax on purchases and services to be claimed against their sales. The industry immediately informed the government and the FBR that reducing the duty to zero could lead to the closure of refineries, which currently supply over 60% of the country’s petroleum products. The implementation of the sales tax exemption proposal would disallow input tax on services for the oil industry, increasing operating and projects cost.

FBR restored 10% duty on HSD calling it regulatory duty and in the last week or so considerable progress has been made and refineries are hopeful that the issue regarding the sales tax will be resolved very soon. Recently, the SIFC called a meeting and emphasized that these issues must be resolved at the earliest for successful implementation of the Refineries Policy. Pakistan has suffered an opportunity loss of $1-1.5 billion per annum due to the delay in implementing refinery policy. If these problems are resolved, three refineries—PRL, ARL, and NRL—are ready to bring in a $3 billion investment, and we are hopeful that the others will follow suit raising the investment to 5 to 6 billion dollars

BRR: All else equal, how do you see the prospects or viability of greenfield investments from Saudi Arabia in Pakistan?

AK: Currently, Pakistan has five oil refineries with a combined capacity to produce approximately 20 million tonnes of petroleum products annually. However, due to a significant decline in furnace oil demand, their utilization is restricted to 50% to 60% of their total refining capacity. Saudi Arabia has shown interest in developing a new oil refinery with a capacity of 300,000 to 400,000 barrels per day. While such a large investment would likely result in a coastal refinery capable of exporting surplus, the feasibility and viability of this project amid changing fossil fuel dynamics remain questionable.

Moreover, substantial investments typically require a conducive operating environment for existing foreign and local players. Currently, the refining sector faces several gaps that need to be addressed before attracting significant investments. These include the need for policy continuity, political stability, and resolving regulatory and operational challenges.

Additionally, such investments often come with certain conditions that may not be acceptable. Our approach has often been about making headlines, which is flawed. I believe the government should prioritize supporting existing refineries willing to upgrade and expand using their current setup and structure rather than starting from scratch to set up a new refinery. Local refinery upgrade is totally a feasible option for Pakistan because it will increase locally refined petrol and diesel that otherwise account for 70% and over 50% in terms of imports.

BRR: What about investing in the petrochemical sector?

AK: The petrochemical sector is indeed open for investment, especially since many chemicals are currently imported. Presently, all naphtha exports serve as raw material for chemical plants, which could be utilized domestically to support a petrochemical complex. However, it is crucial to address the current state of our existing refineries first. We need to ensure that our existing refineries are modernized and operating efficiently. Greenfield investments are more likely to follow when our existing investments are state-of-the-art and thriving.

BRR: How is the current smuggling of petrol and diesel impacting the operations and business of refineries?

AK: Smuggling is not something new, but it has increased significantly in the petroleum products sector over the last couple of years, becoming a major threat to both the refining and the OMC sectors and the government losing huge amount of revenue. While we have occasionally seen some respite, smuggling often bounces back because it is a highly lucrative business. A key factor behind the massive surge in smuggling of petroleum products is the increased taxation, which makes smuggled products significantly cheaper. When smuggling decreases, it is usually contained to Balochistan; however, during peak periods, it can reach as far as Peshawar. Although it has come down recently, it has not been completely eradicated.

BRR: Tell us about the issues with IFEM

AK: The Inland Freight Equalization Margin (IFEM) is a pooling mechanism introduced in 2001to ensure uniform petroleum product rates across the country. It has become a contentious issue within the industry due to its political implications. Periodically, authorities discuss the deregulation of IFEM, and this conversation has resurfaced recently. Deregulating IFEM would result in significant price variations between different cities and oil companies. Consumers close to ports and refineries would benefit from cheaper rates, while those further afield would face higher prices.

However, over the years, the industry has witnessed manipulation and misuse of the freight pool mechanism. This includes compromising on fuel quality by introducing low-quality smuggled products, passing on additional discounts to retailers due to the availability of low-cost smuggled products, and illegal dumping and extra deliveries to other OMC stations or illegal storage facilities.

Refineries have specific concerns regarding the deregulation of petroleum prices. The pricing structure of POL products like Motor Gasoline (MG) and High-Speed Diesel (HSD) consists of six different components: Ex Refinery, Petroleum Levy & Sales Tax, In-Land Freight Equalization Margin (IFEM), Distribution Margin (OMCs), and Dealer Margin.

While we can accept a 10% customs duty on petrol and diesel, we must guard against dumping. According to the Petroleum Rules, OMCs are required to procure from local sources first and only import quantities that are insufficient to meet demand. This safeguard is essential to protect the local industry from unfair competition and ensure its sustainability.

I recommend a phased approach to deregulation. Phase one should involve identifying malpractices through yearly audits. Phase two would entail deregulating IFEM from the pricing structure to address issues related to tax refunds, fake products, and dumping.

BRR: How are you dealing with the decreased demand for furnace oil?

AK: Attock Refinery has an advantage with its furnace oil production amid the ongoing decline in global demand because our furnace oil is low in sulfur (LSFO). There still exists some local demand for LSFO in certain industries like steel and some Independent Power Producers (IPPs). This allows us to sell our furnace oil locally. However, we were also forced to explore export options and discovered that we were able to get a better price than others due to the low sulfur content. Therefore, despite the additional transportation and storage expenses in Karachi, we have managed to export.

BRR: Where, in your opinion, does the energy sector stand?

AK: The issue with the energy sector is that we have been lagging in numerous areas. I remember the times when Pakistan relied 60% on hydroelectric power generation. However, as population growth and power demand increased, the country added thermal energy sources to its mix and that too on imported fuel. Why did it take the country so many years to start Bhasha and Dassu dams? We should have constructed these dams 10 to 15 years ago. What was stopping us? The controversial Kalabagh Dam, actually held us hostage. In Pakistan, Hydel has the greatest potential.

Then, after the IPPs under the 1994 IPP Policy, no investor was willing to come to the country in the subsequent power policy of 2002. At that moment, we initiated Attock Gen, the first IPP to be commissioned under the 2002 Power Policy at internationally competitive cost and plant efficiency of 45%, much better than earlier IPPs of similar technology (up to 40%) and Gencos (up to 30%). We paved the way for others to follow. We and some other IPPs agreed to reduce ROE and local investors gave up dollar indexation in 2021 but today again we are threatened with opening of sovereign contracts and then we expect foreign investment to come in.

The 1990s saw the discovery of 175 billion metric tons of coal reserves in Thar. While China, India, and other countries were expanding their coal power generation, debates about its viability and lignite content persisted for 25 years. ENGRO commissioned the first local coal power plant five years ago, but the country saw the addition of power plants using imported coal. Does this make any sense?

Furthermore, during the last five years, as the country introduced one power plant after another to combat load shedding, it failed to recognize the necessity of upgrading its transmission network to effectively evacuate that power? The current power paradox arises from the lack of work on the transmission side. It’s ironic that the south’s electricity costs Rs 16–17 per unit while the north’s costs Rs 36 per unit, but we don’t have the transmission capacity to move power. IPPs are easy targets but no one talks of the 30% loss due to transmission and distribution, theft and under recovery losses.

Who will invest in this country when a key critical sector is in such a mess?