Price of government intervention
Pakistan is in a difficult situation.The end oil price is being kept at a politically suitable level and the budget deficit is posing a serious threat to macro economic gains. The trade gap is widening and reducing the foreign exchange reserves. The and gasoline and diesel imports have also risen since the closing of the Iranian borders.
Diesel is imported in large quantities and gasoline in small quantity. The pressure on foreign exchange reserves also comes from the import of furnace oil as the local refineries are unable to meet the demand of hydro power plants.
Major steps are needed to maintain economic growth with slender trade gap. Some ills are the outcome of the strong intervention by the government. The oil products were de-regulated and fixation of prices was passed on to the Oil Companies Advisory Committee (OCAC)-- a cartel of the oil industry-- and later on shifted to the Oil and Gas Regulatory Authority (OGRA). Neither OCAC was given free hand nor the OGRA. The government intervenes on three components of price fixation: the ex-refinery price, one price throughout the country and imposition of Petroleum Development Levy (PDL).
One has to look on the oil pricing system presently in place to understand the situation. In the pre-deregulated era, the government used to fix the price on the basis of Import Parity Price (IPP), the actual cost of import which included all types of incidentals. At that time, the government imported the POL products but with coming up of a big refinery i.e. PARCO, the dearth in the case of gasoline was eliminated.
At this stage, the government thought it necessary to deregulate the oil sector. However, a formula was given to the OCAC to follow. The last fortnights Arabian Gulf Price was averaged out to assume the f.o.b. prices. The incidentals i.e. freight, premium factor, insurance, bank charges etc were then added to this to arrive at the ex-refinery price. The IPP formula is still in place although the imports had been limited only to diesel.
The import of HSD is almost 50 per cent of the total requirement. The strange thing is that whether any import has taken place or not, the formula has been followed in all the products. It is estimated that while adding the incidentals, there is an increase by $30-35 per ton causing a padding of about Rs2-2.50 per litre.
The second factor is the government’s desire to keep a uniform sales price across the country through adjustment in the Petroleum Development Levy (PDL). However, it is now being done through paying subsidy to both-- Oil Marketing Companies (OMCs) and the refineries. Since May, 2004, when the international oil prices started rising from $35.6 per barrel, the impact of the Petroleum Development Levy (PDL) on diesel was brought down-- to zero by August, 2004-- when the crude oil price went up to $39.28.
As the cost exceeded the sale price, an element of Price Differential arose and the Oil Marketing Companies (OMCs) and Refineries started claiming rise in the end sales price which were determined by the government. This is continuing and the cumulative impact has already crossed $3 billion in the shape of no revenue from PDL and on account of subsidy.
The government has allowed the OMCs to add to their sale price an average cost of transport i.e. Inland Freight Equalisation Margin (IFEM). This is determined by the OMCs and there is no involvement of the government.
The rise in the crude oil prices has no direct linkage with the working of the ex-refinery price. However, one thing is sure that higher the crude prices, higher the ex-refinery price. As already mentioned the ex-refinery price is determined on the basis of IPP and the overheads are linked to it as such any increase in the ex-refinery price causes an additional earnings for two main stakeholders i.e. government by way of GST and OMCs and distributors due to a fixed percentage of margins. In this way, the net loser is the ultimate consumer.
The refineries are better placed as they are fixing the ex-refinery prices with presumptive overheads. OMCs can only gain more if the ex-refinery prices are increased. The government earning is affected due to capping of end price. In other words, the government earning is facing a double cut. Due to capped prices it is getting less revenue and also paying subsidy. The consumers gain because the prices are kept at an affordable level.
Because of the capping of the prices, government’s earnings have gone in negative. Whatever the gains from the GST (15 per cent of the capped prices) have evaporated because of larger gulf between the cost of diesel and far lower sale price. The subsidy bill on this account is likely to touch Rs200 billion, if the current rate is allowed to continue.
What is happening around us matters most. In China, the gasoline and diesel prices are Rs41.20 and Rs43.05, respectively. China has in the recent past reduced the subsidy level from 3--0.1 per cent of the budget outlays. In India, the average price of gasoline and diesel are Rs67.65 and Rs47.36, respectively (recently reduced by a thin margin). India is financing huge subsidy bill both through budget and bank borrowing. Malaysia is providing heaviest subsidy in the Far East region by keeping the gasoline prices at Rs35.67 and diesel at Rs29.52 per litre.. The subsidy forms 11 per cent of the total budget outlays or $4.5 billion.
Inflation is running in double digits more because of high food prices followed by the oil price hike. The question is, what should be the inflation rate that does not compromise the growth level. With the present policy, the government and end consumers are suffering but the OMCs and Refineries are profiting. The refineries are gaining on two counts: 10 per cent deemed import duty and the Import Parity Price (IPP).
A giant refinery is coming up largely because of extended incentives. It will refine the crude and get the benefits of IPP. In fact, the IPP formula was good when the government was actually importing both gasoline and diesel. With coming up of PARCO and now the new one, Pakistan would not be importing any quantity. The refined oil is expensive in the Gulf and beyond, so we should do away with the IPP and fix our own prices (weighted).
The export of gasoline and by-products has been made irrelevant. The export of naphtha by coastal refineries is not counted towards the fixing of local prices. In all fairness, both import and export parity price should be taken as the basis for the fixation of local prices. “Other income” is taken separately but counted towards overall profitability. In the present formula the ‘other income” is not deducted from the ex-refinery price. The ex-refinery price is determined on the basis of IPP and the gains of refineries on other counts are ignored.
The following recommendations are made to rectify the situation:
* The IPP formula to determine the ex-refinery should be abolished and instead FOB Average Gulf be taken to determine the ex-refinery price. In all fairness, the ex-refinery prices should be determined by refineries themselves rather than under a government formula.
* The overhead cost i.e. transportation, premium, bank charges, insurance and wharfage should not be allowed on deemed basis.
* The Inland Freight Equalisation Margin (IFEM) should be determined by OGRA and not by the OMCs. At present, the OMCs determine the IFEM without any check.
* The benefit of 10 per cent import duty on diesel also goes to the refineries as deemed duty. It should be abolished altogether.
* GST on diesel be eliminated for a certain period until a proper oil study is conducted. With the present increase in the prices of diesel, the government tax revenue has also increased. The formula is simple i.e. higher the price higher the GST. The overall effect will still be negative. The government should not fear of missing the revenue targets or the declining percentage of the ratio with the GDP. There is no fun in collecting from this source and providing subsidy through bank loans at a much higher cost.
* The end prices should not be determined on last fortnights’ average. It should be done on consignment basis. For the crude oil it may be workable but in the case of diesel, some fortnights go without any import. It should be in such a way that the cost of imported diesel should be averaged out with the locally produced diesel.
* The government should create an Oil Fund which may be kept outside the budget. The general public may be asked to invest. The institutionalisation of this fund will help keep the deficit at an affordable level. These measures will help reduce the end prices by a significant margin. This is quite unfair that one of the stakeholders gains at the cost of government and the consumers.