New Oil Refinery Policy (NORP) is at an advanced stage of processing and approval. There are some risks and issues in the proposed policy which deserve deeper. The following are the major provisions:
i) Tax holiday of 20 years for new large oil refineries and of 10 years for the modernization and expansion of the existing refineries; ii) 10% price preference on petroleum products; iii) elimination of custom duties and other levies on import of crude oil; iv) Competitive oil policy after 2026 and yet market restrictive provisions, etc.
Pakistan’s oil demand has been going down partly due to reduction in FO (furnace oil) consumption. In the year 2019-20, Pakistan’s annual petroleum consumption was 17 million tons while production 9.45 million tons and imports were 7.55 million tons. This means a capacity gap of 300,000 bbl/d. Existing refinery capacity is 417,000 bbl per day (14.45 MTPA). The largest oil refinery is BYCO with a capacity of 150,000 bbl/d followed by PARCO 100,000, Attock (ARL) 53,400 bbl/d, NRL 64,000 bbl/d and PRL 50,000 bbl/d. Capacity utilization of existing refineries is around 50% which is their main source of financial problems. Many projects for new oil refineries are in competition each around a capacity of 250,000 bbl/d: PARCO-Hub, Saudi-Gwadar, and PSO-PakChina, etc., while the requirement may not be for more than one project.KP government is also pushing for smaller refineries based on oil production in that province.
Oil refineries are highly competitive and low margin business and sensitive to scale. Wood Mackenzie’s forecast for composite Oil Refinery margin average is of USD 1.8 /bbl less than half of the last five year average of USD 4.25/bbl. Many factors influence the economics and profitability of an oil refinery, size, crude specs, distance to oil fields, capacity utilization, product mix and quality, etc. The largest oil refinery is in India at Jamnagar with a capacity of 1.2 million barrels per day, while the average economic capacity is said to be 200-400,000 bbl/day depending upon the individual factors. Capacity utilization should not be less than 80-85% to be economic under contemporary conditions.
There is a controversy regarding the desirability or lack of it in installing oil refineries. These are: being capital intensive, comparatively low employment creation, not significant foreign exchange savings as crude oil continues to be imported and has more than 60% share in cost structure, scale economies, complexities of international market fluctuations, higher cost and prices, being tied up with old technologies and low quality petroleum. As has already happened in Pakistan, refineries could not maintain profitability and could not invest in expansion and modernization. As for self-sufficiency and energy security argument, it is shifted from one product to the other (crude oil). It is often asked: ‘Is it worth bending backwards for attracting FDI in this respect and extending excessive concessions?’
It appears that excessive and discriminatory incentives have been given in the proposed policy to encourage installation of new oil refinery, while existing oil refineries are getting much lesser incentives. Local refineries, if at all, need more subsidies and support due to their smaller capacities.10 years’ tax holiday for local versus 20 years tax holiday for DFI appears to be discriminatory. Oil refineries of 200-400,000 bbl/d do not require any support or subsidies due to the scale of economy, these enjoy.
There is abundant evidence in economics literature that tax holidays have worked to the detriment of host countries. Investors go for real economics and not crutches. It is the rapacious investors who demand such tax breaks generally. After all where will the GoP get revenues? If somebody makes profit, he should pay tax. If something is not economic, it should not be invested in.
A 10% price subsidy is also considered excessive which will be reduced to 5% in five years after commissioning of the refinery. There is already subsidy in terms of landed cost rather than F.O.B. To alleviate the impact of this subsidy on retail prices, competitive market is being promised or proposed. In the first place, such promises and undertakings should not be made in government policies. What if for a variety of reasons, GOP is not able to implement such policy provisions. We will discuss the risk involved later in this space.
It is being assumed that competitive oil product pricing regime would result in lower prices—far from it. There is abundant evidence that competition does not result in lower prices. It has not worked in case of sugar, cement and fertilizers. Fertilizers are being sold at identical prices while gas is being supplied to fertilizer plants at different prices to each one. Competition Commission of Pakistan (CCP) has imposed a fine of Rs. 40 billion on sugar companies. Thus in order to balance the effects of one mistake of providing high (10%) price subsidy, another mistake of freeing prices is being introduced. Also, how will the competition be effective when market/import limiting clauses would be there?
The existing regulated system is not so bad. In fact, it is working very well. It is based on international prices. There is only a component of Rs.10.0 which is locally determined by OGRA (oil and gas regulator). If there are some complaints of oil marketing companies’ (OMCs’), these can be negotiated and a more realistic and fair costing can be done. There are issues of transparency in IFEM which could be partly handled as well.
The most risky aspect of the new policy is allowing free pricing which will result in location based pricing. It means, petroleum prices would be, e.g., Rs.10 cheaper in Karachi and Rs.10 expensive in KP. Will it be politically acceptable to all parties? Our system is based on uniform pricing. Thus change for just making a change may not be a good policy or making a mistake and then trying to compensate it by another mistake. Under this system, in India, diesel prices are Rs 98 in Agra and Rs.110 in Bhopal. Although, it is free market there, the union government controls 90% of the capacity. Differences would have been larger had it been private sector.
A competitive market can only be established by keeping imports free and unrestricted. A share of the imports should be left for OMCs, otherwise, the new and powerful oil refineries will be dictating the price. If investors for new oil refineries find Pakistan market attractive enough, let them come without undue incentives. It may be noted that there is ample advantage being given to new oil refinery investors. New Refineries will assure them a market for a long time in a scenario of falling demand and higher competition in international markets.
Table 2.1: Sectoral Consumption of Petroleum Products
Sector MS + HOBC High Speed Kerosene Aviation Furnace Light Diesel Total Total Non Grand + 100 LL Diesel Fuel Oil Oil Energy Energy Total==============================================================================================================================================Transport 7.48 6.09 0.00 0.29 0.00 - 13 86 0.13 13.99Power - 0.01 - - 1.51 - 1.53 0.00 1.53Industry 0.02 0.38 0.01 - 0.82 0.00 1.22 0.11 1.34GOVERNMENT 0.02 0 15 0.04 0.17 0.00 0.00 0.37 0.07 0.44Domestic - - 0.05 - 0.00 - 0.05 0.00 0.05Agriculture - - - - - 0.01 0.01 - 0.01Overseas/Export - 0.01 - 0.24 0.03 - 0.28 - 0.28Total FY 2019-20 7.51 6.63 0.09 0.70 2.37 0.02 17.32 0.31 17.63Total FY 2018-19 7.69 7.36 0.10 0.98 3.54 0.03 19.69 0.35 20.03Growth (%) (2.30) (9.89) (13.51) (28.36) (33.03) (22.26) (12.03) (8.92) (11.98)==============================================================================================================================================(Source: OCAC)Product PSO TPPL APL SPL GO HASCOL BPPL BEE Others TOTAL=====================================================================================================================MS 2.89 0 99 0.67 0.83 0.69 O.54 0.26 0.19 0.40 7.45HOBC (95/97RON) 0.02 0.01 0.00 0.O1 0.00 0.00 - - 0.00 0.06HSD 3.04 0.68 0.64 0.46 0.57 0.48 0.35 0.18 0.24 6.63FO 1.09 0.09 0.42 0.00 - 0.07 0.42 0.04 0.23 2.37JP-I 0.52 - O.01 0.02 - - - - 0.00 O.55Kerosene 0.06 0.01 0.02 - - - 0.00 - - 0.09LDO O.01 0.00 0.01 - - - 0.00 - 0.00 0.02100 LL - - - - - - - - 0.00 0.00=====================================================================================================================TOTAL 7.62 1.78 1.76 1.33 1.26 1.09 1.03 0.41 0.88 17.17=====================================================================================================================(Source: OCAC)Product RARCO BPPl ARl NRL PRL ENAR Dhodak Total=======================================================================================================AVIATION Fuel 0.25 0.01 0.14 0.08 0.07 0.02 0.00 0 56FURNACE OIL 0.53 0.69 0.30 0.30 0.32 0.09 0.00 2.22HSD 1.22 0.90 0.48 0.63 0 51 0.05 0.00 3.79KEROSENE 0.02 0.00 0.04 0.00 0.01 0.01 0.00 0 08LDO 0.01 0.01 0.01 0.00 0.00 0.00 0.00 0.02LPG 0.09 0.04 0.00 0.01 0.02 0.00 0 26 0.41MS 0.66 0.40 0.49 0.20 0.22 0.00 0.00 1.97NAPHTHA 0.00 0.07 0.04 0.1l 0.06 0.1l 0.00 0.38=======================================================================================================TOTAL 2.79 2.10 1.50 1.33 1.20 0.27 0.26 9.45=======================================================================================================(Source: OCAC)Chinese experience of Tea-Pot refineries (small refineries euphemistically called so) could be of great value. China has graduated from installing, upgrading and graduating from Tea-Pot refineries to large oil refineries, as they graduated from small blast furnaces to large ones in steel making. Tea-Pot refineries refined imported and local Furnace Oil. Similarly, in our situation, one refinery can be installed to combine the furnace oil produced in all other refineries. Tea-Pot refineries can be relocated from China saving a lot of capex.
It may be worth-while exploring the possibilities of attracting vertically integrated international companies which offer a whole bouquet of products and services starting from E&P, refining and marketing. Three of the top ten oil companies of the world are Chinese. The question is whether CPEC can be involved. Russians may also be interested. Is it too optimistic? Is Pakistan market large enough? Such companies may deserve attractive concessions.
Concluding, it is proposed that Tax-holidays should either be removed altogether or reduced to ten years only, doing away with discrimination.10% price advantage may also be reduced to 5% if not eliminated altogether. A competitive regime will increase the retail prices and create price disparity endangering national harmony. Competitive regime, if at all, should be without market limiting provisions. Policy should not have risky provisions.
(The writer is a former Member Energy, Planning Commission; author of
several books on the energy sector)
Copyright Business Recorder, 2021