Oil prices have gone through the roof this year, leading to fuel prices at petrol pumps in Pakistan going up sharply in the last twelve months, even with the PTI government subsidising petrol and high-speed diesel prices and slashing petroleum levy and sales tax to zero, a decision which the newly inducted Prime Minister Shehbaz Sharif has maintained.

The oil price rally has also sent shockwaves around the world, and understandably so, given that some previous oil price shocks have been harbingers of economic downturns in developed countries like the US. We’ve seen this happen with the Arab oil embargo of 1973 and the oil price rally of 2008.

To contain prices at the pump, the US and 30 other countries from the International Energy Agency will release an unprecedented 240million barrels from their strategic reserves in six months. This news has provided some respite but the Brent oil price stubbornly remains above $100 a barrel, substantially higher than under $70 this time last year.

However, this isn’t the first oil price shock that the world is facing and likely won’t be the last. In fact, the large changes in oil prices have been an integral part of the commodity cycles and are usually driven by sudden shifts in global demand, supplies, or geopolitical events.

In 1973 when the Arab countries stopped supplying oil to Western nations due to the latter’s support of Israel in the Yom Kippur

Oil’s recent bullish run is being fueled mainly by four factors — the post-pandemic surge in demand, relatively modest increase in supplies as members of the Organisation of the Petroleum Exporting Countries plus and the US shale oil producers raise crude oil production slowly, reduction in global oil and fuel inventories, and the sanctions imposed on Russia following its attack on Ukraine that disrupt Russia’s oil exports.

Although the oil price shocks are painful, the Western governments often take critical lessons from these episodes and use them as an opportunity to enhance their energy security. In 1973, for instance, when the Arab countries stopped supplying oil to Western nations due to the latter’s support of Israel in the Yom Kippur War, oil prices surged from less than $3 to nearly $12 per barrel.

This prompted Western governments to enact policies that accelerated the development of their domestic petroleum sector. Countries such as the US lifted their oil and gas production and improved their oil refining and natural gas processing capabilities. This put them in a better position to handle future oil price shocks. Pakistan must also think along these lines.

It is critical that policymakers in Pakistan reassess the energy policy and work towards making the country more resilient to oil price shocks. Note that Pakistan incurred a massive trade deficit of $39.26 billion in the first ten months of the ongoing financial year, up 65 per cent from last year, as per data from the Pakistan Bureau of Statistics, due in large part to the soaring imports of crude oil, refined products like petrol and diesel, and LNG.

Meanwhile, the sale of the petroleum products climbed by 17pc in the first ten months of the fiscal year, with the three main products — motor spirit (petrol), high-speed diesel and furnace oil — seeing double-digit growth, as per data from the Oil Companies Advisory Council (OCAC). With the increase in volumetric sales of petroleum products and persistently high energy prices, the trade deficit might get worse in the future, further hurting the economy.

There are several actions our policymakers can take that can strengthen the country’s energy supply chain and bolster its ability to withstand oil price shocks. Effective measures need to be taken to lift domestic production of crude oil, natural gas and refined petroleum products.

Production of petrol, diesel and other refined petroleum products can be increased fairly quickly, given the country already has enough refining capacity to meet a vast majority of its demand. The problem is that the refineries often run below their nameplate capacities, primarily due to low and inconsistent upliftment of furnace oil.

In the first nine months of this fiscal year, the five refineries in Pakistan operated at around 60pc of their throughput capacities, on average, based on data from an OCAC report. The policymakers should sit with the refiners and power producers — the primary consumers of furnace oil — and lay a roadmap for future furnace oil consumption to bring much-needed clarity and stability to this space.

Once furnace oil upliftment gets better, the refinery utilisation should climb significantly which will lead to higher production of petrol and diesel. This will likely reduce the country’s need to import these expensive fuels. The local refineries currently satisfy just 30pc of the nation’s petrol and 70pc of diesel demand.

Moreover, the government should also introduce investor-friendly policies that can encourage growth in the domestic oil and gas exploration and production (E&P) industry. Although Pakistan does not hold sufficient oil and gas reserves to meet all of its requirements, when it comes to hydrocarbon exploration, no stone should be left unturned.

The performance of the government-owned E&P companies like Oil and Gas Development Company Limited, which have been struggling with declining production, should be improved. More importantly, incentives, such as lucrative PCAs (Petroleum Concessions Agreements) and PSAs (Production Sharing Agreements) should be offered to attract local and foreign energy companies and increase onshore and offshore E&P work.

An increase in domestic oil and gas production can strengthen the entire energy value chain and help save forex reserves, and this can be done by enacting policies that can catalyse private-sector investment in the energy industry.

Additional cues on strengthening the country’s energy supply chain so that it can stand firm against oil price shocks can be taken from the experience of Western governments, including expanding strategic oil reserves and taking measures that improve energy efficiency.

The author focuses on subjects of business and economics, specialising in the energy sector.

sarfaraz@halfbridge.com

Published in Dawn, The Business and Finance Weekly, May 16th, 2022