ABSTRACT

Instability in the policies affecting the

petroleum sector has hampered its
growth. The petroleum levy has been
changed according to each government’s
fiscal needs, and popularity. While the
country still faces circular debt in access of
PKR 300 Billion, the sector is still growing.
The impact of reducing the burden on
furnace oil through alternative energy
sources has although been successful, but
has also been subject to mismanagement
and controversial decisions.
Mudassir Anwar (16304), Saad Asif Moten
(15955)
Pakistan Economic Policy
PETROLEUM SECTOR
OF PAKISTAN
[Document subtitle]
 Contents
Literature Review................................................................................................... 2
INTRODUCTION...................................................................................................... 4
Impact of Oil Price on Economic Factors ................................................................ 7
Current Scenario .................................................................................................. 11
The Circular Debt Issue ........................................................................................ 16
Oil price and monetary policy .............................................................................. 18
The Case of Liquefied Natural Gas ....................................................................... 20
The case of Compressed Natural Gas ................................................................... 22
Petrol Pricing Formula ......................................................................................... 24
Conclusion ........................................................................................................... 26

pg. 1
 Literature Review

According to (Mignon.V, 2008), the author aims to investigate the relationship

between oil prices and financial variables. The sample is collected from three group
of countries which are OPEC, Oil exporting countries and oil-importing countries.
The variables used are CPI, Gross Domestic Product, Household consumption,
unemployment rate and share prices. The author uses Granger Causality tests,
cyclic correlations, Time series cointergration tests and then using Multivariate
model. The author concludes that there exists strong causality running from oil to
share prices, especially for oil-exporting countries. Turning to the long term
analysis, the majority of long-run relationships concerns GDP, and unemployment
rate and share prices. The relationships between oil prices and unemployment
rates or share prices only concern non-OPEC members. Concerning share prices,
the causality is negative and always runs from oil prices to stock markets, putting
forward the key role played by the oil market on financial activity.

According to (Akram, 2005) Pakistan being a small and still developing economy is
volatile to oil price shocks compared to other developed economies. The paper was
focused on the subcontinent i.e. India Pakistan and Bangladesh. (Akram, 2005) used
the VAR model and Wald Granger causality test to test the impact of changes of oil
prices on the economy. However the Granger test concluded that oil prices did not
have a significant impact on the economic growth of Pakistan and Bangladesh,
however it did have an effect in case of India and other larger economies. The
argument presented is that larger economies have bigger energy sectors thus the
shock in oil prices had a greater impact.

pg. 2
According to (Ahmad, 2015) the research is particularly aimed to determine the
existence and intensity of relation between crude oil price and inflation in Pakistan.
The data used here is from 1979-2012. For long run and short run results Johansen
Co-integration techniques have been employed for estimation. The dependent
variable used here is GDP deflator and independent variable used here is real GDP,
money supply, crude oil price, exchange rate, and weighted average rate of return
on deposits, Indirect taxes. The author used Dicky fuller test and Cointegration test.
The analysis of data from 1979-2012 suggests that increase in money supply, crude
oil price, exchange rate, interest rate, and indirect taxes accelerates inflation while
increase in real gross domestic product leads to a downward movement in general
price level in short and long span of time.

pg. 3
 INTRODUCTION

Oil and Gas sector in Pakistan has seen phenomenal growth since the
independence in 1947 when oil quantities produced were scarce. At that time
there was no gas production. Over the past half century the petroleum industry
has played a significant role in national development by making large indigenous
gas discoveries. With looming energy crises and the ongoing growing demand for
oil and gas in Pakistan, the exploration and production of oil & gas, or upstream
has garnered considerable interest from investors (both local and foreign).

We need not mention that the oil & gas industry is complex, extensively
regulated and rapidly evolving to keep up with the global markets and initiatives.
As such, the following is only intended to provide a high level summary and
should not be construed as an exhaustive analysis of all regulatory/legal issues
that will be affect a potential investor. Accordingly, specific financial, legal and
regulatory advice should be sought to ascertain and understand the applicable
legal and fiscal regime before any investment decision is considered.

AN OVERVIEW OF LEGAL REGIME

The upstream activities in the oil and gas sector are administered and regulated
through the Directorate General of Petroleum Concessions (DGPC) of the Policy
Wing, Ministry of Petroleum and Natural Resources. Other regulatory bodies such
as the Competition Commission of Pakistan and environmental agencies in
specific set of circumstances can exercise jurisdiction in respect of transactions
affecting the competition laws and environmental laws (as applicable). The Oil &
Gas Regulatory Authority (OGRA) is a primary regulator for the midstream and
downstream oil & gas industry and does not prima facie exercise regulatory
control on the upstream sector. Be that as it may, in certain limited circumstances
such as determination of wellhead prices, OGRA has exercised jurisdiction in the
upstream sector. The potential regulatory overlap in such limited context is a
complex area of law and subject to considerable legal debate.
The basic law that regulates the upstream sector is the Regulation of Mines and
Oil Fields and Mineral Development (Government Control) Act, 1948 (the 1948

pg. 4
Act). The main purpose of the 1948 Act was to provide the basis for creating a
legal framework for mineral development and production, and empower the
Central and Provincial Governments to make rules in respect of various matters
concerning mineral resources. The majority of the Rules governing the upstream
petroleum sector have been made pursuant to section 2 of the 1948 Act. Though
the 1948 Act provided that the power to make rules and regulations in respect of
the petroleum sector would vest in the Central Government, it did not address
the question of ownership of mineral resources including petroleum. This lacuna
was filled by Presidential Order 1961 which provided that all minerals and rights
pertaining there to shall stand acquired by and transferred to and shall vest in the
Central Government, notwithstanding any law, custom, usage, agreement, decree
or order to the contrary. It also provided that this acquisition of minerals by the
Government shall be free from all encumbrances.
Prior to 1986, exploration for oil and gas and their production was governed by
the Pakistan Petroleum (Production) Rules, 1949 (the 1949 Rules). These Rules
were made pursuant to section 2 of the Regulation of Mines and Oilfields and
Mineral Development (Federal Control) Act, 1948. Leases pursuant to these rules
are known as “Oil Mining Leases”. The 1949 Rules continue to apply to the Oil
Mining Leases that are still in subsistence.
Leases granted after 1986 are governed by the Pakistan Petroleum (Exploration
and Production) Rules, 1986 (the 1986 Rules) A lease granted under the 1986
Rules is known as “Development and Production Lease. The 1986 Rules were
replaced on 2001 by the Pakistan Petroleum (Exploration and Production) Rules,
2001 for onshore areas and in 2003 by the Pakistan Petroleum (Exploration and
Production) Offshore Rules, 2003 for offshore areas. The 2001 Rules were
replaced by the Pakistan Petroleum (Exploration and Production) Rules, 2009 and
very recently the Pakistan Onshore Petroleum (Exploration and Production) Rules,
2013 Pakistan’s oil & gas industry first captured interest of investors when the
Exploration and Production Policy of 1991 was introduced. Through subsequent
improvements in the policies of 1993, 1994, and 1997 Pakistan was generally
regarded as an attractive location for upstream investment. Pakistan overhauled
the policy in 2001 and accordingly introduced corresponding Rules in 2001 for
onshore areas and in 2003 for offshore areas as discussed above. New policies
revising the tax, fiscal and commercial regimes were issued from time to time.

pg. 5
The last policy was revised in 2012 which has made several useful revisions to the
tax and pricing regime from the position contemplated in the previous policy. A
new Model PCA has also been issued incorporating changes in policy and
reflecting changes in the Rules. It may be important to note that the regulatory
regime provides option to the holder of the petroleum right to convert to a later
policy and take advantage of the revised regime. Such conversion is subject to
amendment of the underlying PCA (as approved by the Government) in order to
make the same consistent with the new policy and the underlying Rules thereof.
The requirements to exercise conversion option available under the policy
framework are dealt with in the underlying policies and specific advice should be
obtained prior to exercising the conversion option.

pg. 6
 Impact of Oil Price on Economic Factors

Oil prices saw a surge continuously after 2003 reaching a peak of $s137/bbl in July
2008, but after that a declining trend has set in. Since 1970s it was the fifth main
negative oil shock. The first one was in 1973-74 as a result of the OPEC oil
embargo; and secondly in 1978-79 when the OPEC put restraint on its production.
This upward flow in oil prices continued until mid-1980s, whereas Iran Iraq war in
early 1980s had its share in escalating it further. However in 1986, when Saudi
Arabia increased its crude oil production, oil price decreases. In 1990, Iraqi
invasion of Kuwait leads to another price shock but it receded in a year, as a result
of Asian financial crisis. In 1999-2000 the OPEC again limited its production
leading to another price shock. Final oil price shock take off in 2003 which
continued till July 2008. In other words, oil prices have always remained fairly
volatile.
These shocks raised serious concerns among the policy makers around the world.
The adverse economic impact of higher oil prices on oil-importing developing
countries is generally considered as more severe than for the developed countries
as they are more dependent on imported oil and are more energy-intensive
(inefficient use of energy)1 (IAE 2004). In particular, the surge in the oil prices
(2000s) worried economists regarding its potential adverse impacts; as this
upward trend in the price of oil has hurt the economies of many countries in the
world including that of Pakistan, in terms of creating inflationary pressures in the
economy, increasing budget deficit and balance of payment problems (Malik
2007).

pg. 7
Pakistan with a population of more than 150 million was on the path of rising GDP
growth in the early 2000s, but the continuous rise in oil prices in this decade is
regarded as one of the contributory factor. Energy sector has a direct link with the
economic development of a country. In line with the rising growth rate of GDP,
demand for energy has also grown rapidly. The magnitude by which economies
are hurt as a result of price shock depends on the share of cost of oil in national
income, the degree of dependence on imported oil and the ability of end-users to
reduce their consumption and switch away from oil. In the energy mix for the
year 2005-06, oil accounts for 32 percent of the total energy used in Pakistan.
Although the intensity with which oil is used in total energy consumption has
declined in the last few years but still it is the second largest source of energy
used after natural gas, which accounts for 39 percent. As far as the energy
intensity is concerned it has remained almost constant since 1990-91 (i.e., 1 %).
Decrease in energy intensity is considered as the most promising route for
reducing vulnerability to oil shocks (Bacon 2005).

With oil being the second largest source of energy used along with almost a
constant rate of its production Pakistan is heavily dependent on oil imports from
Middle East exporters (Saudi Arab playing the lead role). Almost 82% of the
demand for petroleum products in the country is met through imports. Pakistan
spent about 44 percent of export earnings on oil imports in 2006-07. This
percentage was only 27 percent in 2004-05. Therefore, the international oil price
fluctuations have a direct bearing on the macroeconomic of the country,
especially on the oil price GDP relationship.
The share of net oil imports in GDP is an index of the relative importance of the oil
price rise to the economy in terms of the potential adjustments needed to offset
it. For Pakistan over the last few years, this ratio rised from -3.13 in 1990-91 to -
5.24 in 2005-06 (Malik 2007). With such a high ratio, unless country is running in
surplus, or has extremely large foreign exchange reserves, high oil price is dealt by
severe macro-economic adjustments.
The goal is to shed light on the nature of the impact of oil shocks on the
macroeconomic conditions for Pakistan. Our group will analyze the impact of oil
price on the output growth of Pakistan using the open economy IS function along
with the monetary policy function on the presumption that State Bank has

pg. 8
pursued inflation targeting and conducts monetary policy to maintain price
stability and output growth.
Higher oil prices are expected to affect a macro economy through various
channels. Oil price increase leads to a transfer of income from importing to
exporting countries .It changes the balance of trade between countries and
exchange rates. Net oil-importing countries normally experience deterioration in
their balance of payments, putting downward pressure on exchange rates. As a
result, imports become more expensive and exports less valuable, leading to a
drop in real national income. These countries are expected to face a large import
bill, which might leads to the reduction in total demand for all imported goods so
as to restore balance of payments equilibrium. Or net exports are expected to
decline if the amount of oil imports and other factors remain the same. The only
exception is where the country is running in surplus or has extremely large foreign
exchange reserves. Since oil is used as an input in the production process, to
generate electricity and to transport output to the market. Higher crude oil price
is expected to raise the price of petroleum products, thus transport costs,
electricity bills, etc. and thus it will leads to inflation, reduced non-oil demand and
lower investment in net oil importing countries, thus having a significant impact
on employment and output as well. It would reduce real wealth and consumption
spending.
Higher production cost lowers the rate of return on investment, which affects
investment demand negatively. In other words, adverse effects on supply. Tax
revenues fall and the budget deficit increases, due to rigidities in government
expenditure, which drives interest rates up. It is not the rise of oil price that
reduces the economic activity, but it is the response of the monetary policy to the
oil price shock.
In addition, the adverse impact of higher oil prices on oil-importing developing
countries is generally more evident for most indebted countries. Fiscal imbalances
would be aggravated in those developing countries like Pakistan that provide
direct subsidies on oil products to protect poor households and domestic
industry. The burden of subsidies tends to grow as international prices rise,
adding to the pressure on government budgets and increasing political and social
tensions. Increase in oil prices gives rise to our debts and import bills. This is
corrected through expansionary monetary policy and fiscal policy.

pg. 9
At this point, it would be important to discuss the behavior of the interest rate in
Pakistan. For the period of 1992-2010, the average interest rate was 12.78%; it
reached the historical high of 20% in October 1996. It was recorded at its
minimum level 7.5% in November 2002.A detailed graphical representation of
these facts follows below. The historical rise took place in the fourth quarter of
the year 2000 with a rise in 540 basis points. Such spikes are very obvious, and the
most notable examples are fourth quarter of year 1996 and fourth quarter of year
2000. Such large movements in interest rate are very detrimental because
investment is sensitive to change in interest rate. First, it creates uncertainty in
the economy because all previous investment decisions become suboptimal.
Second, it discourages the new investment because cost of doing business
increases in case of higher interest rate.
Now we move on to look at the pattern of oil prices. Historical data reveals eight
oil price shocks in Pakistan during the period of analysis. Furthermore, four of
them were more devastating in terms of their relative change. For movements in
oil price shocks and resultant adjustments in macroeconomic variables. It is
evident that there are production losses whenever an economy is hit by an oil
price shock. It seems as if oil price shocks are causing loss in production but the
role of interest rate cannot be ignored at this stage. The State Bank of Pakistan
(SBP) raises its discount rate to overcome inflationary expectations that might
arise from oil price shocks. This tight policy response by SBP might be the source
for stable inflation in most of the episodes. It is important to note that domestic
oil prices are linked with international oil price since the last decade. It is a
challenge for policy makers to overcome the negative aspects of oil price shocks
because in Pakistan it is more vulnerable to oil price shocks after linking the
domestic market with international oil prices. That is why the oil price shock of
2008 was the most devastating compared to previous oil price shocks resulting in
overall terms 25% inflation, 15% discount rate and a meager 2% GDP growth rate.

pg. 10
 Current Scenario

The International Oil Market

In 2014 an oil glut was created, enlarging the demand supply gap currently
accounting to 1.8 mb/d. This led to a massive fall in the international prices of
crude oil. Since mid-2014 the price of West Texas Intermediate (WTI) has
decreased by 70%, currently trading at $31. Amid the meagre economic growth in
the major Oil Importing countries i.e China, EU and USA, the trend has continued
the downward trend.
USA is the world’s largest oil consuming country, in 2014 it alone accounted for
world’s 21% crude oil consumption United States consumes 19.4 M bpd. The
other major consumer of oil is China which consumes 10.4M bpd.
Until recently USA imported huge quantities of crude oil to meet its demand,
many of its crude oil imports were from Saudi Arabia. USA during the past years
has invested huge amounts of money on hydraulic fracturing. Hydraulic fracturing
is the process of drilling and injecting fluid into the ground at a high pressure in
order to fracture shale rocks to release the crude oil trapped within them.
Currently there are more than 500,000 active wells in USA which are extracting
through hydraulic fracturing. By extracting huge quantities of crude oil USA was
able to meet most of its crude oil demand and hence its imports of crude oil
decreased. USA is producing 13.77 mb/d currently but according to OPEC the
price pressure will cause a decrease in supply by approximately 0.17 mb/d. The
graph below compares the oil production and net oil imports of USA from 2008-
2015. The net oil imports have been continuously decreasing, being lowest in
2015, while the crude oil production is continuously increasing being highest in
2015.
As USA became more self-sufficient in meeting its crude oil needs, the demand for
oil in international markets fell down. This should have been followed by a fall in
supply, so that the prices would have remained unchanged. However, Saudi
Arabia which is a the major oil exporter refused to cut down its production, many
say this was done because Saudi Arabia wanted to drive the USA’s hydraulic
fracturing firms out of business. Hydraulic fracturing is an expensive process and

pg. 11
is only profitable if the oil prices are high. In a recent OPEC meeting Saudi Arabia
changed its rigid stance on not cutting down oil production. Saudi Arabia
suggested that it would reduce its oil production if all other OPEC members
agreed to do the same. In 2016, world oil demand is expected to grow by 1.25
mb/d, partly supported by the improvement in global economic activities.

Iran’s removal of sanctions

Iran used to be a major exporter of oil until January 2012, when sanctions shut
Iran out of the oil market. It is expected that these sanctions will be removed by
January 2016 as a deal was signed in Vienna by Iran and six major world powers
on July 14, 2015. The return of Iran in the international oil market would further
increase the supply and could lead to a further fall in the prices of crude oil. The
graph below compares Iran’s oil export pre sanction period and during the
sanction period.

pg. 12
The graph above compares Iranian oil exports in 2011 and 2014. In 2011, when
Iran did not have sanctions on exporting oil, it exported 2,610,000 bpd while in
2014 it only exported 1,402,904 bpd. During 2014 China and India were major
importers of oil from Iran.
OPEC member Iran currently produces 1.1 million barrels of crude oil per day and
hopes to get back to its pre-sanctions level of 2.2 million, last reached in 2012.
Zanganeh, believes to double the capacity without the permission of OPEC,
however viewing this on a broader prospective seems unlikely. The impact of
Iran's return to the market greatly depends on how quickly they can ramp up
production. Due to the sanctions a lot of oil producers have stopped operations in
the region and the lack of demand has eroded the infrastructure required to get
back to the pre-sanction position. To double the production, the oil ministry plans
to attract investment worth $100-$500 billion in the course of next 5 years and
expects hefty foreign investments for this purpose. With the oil prices reaching a
historic low, it’s unlikely that investors would be attracted in less profitable
venture, however if the price reaches stability it could favor Iran’s cause.

Russia increasing the oil supply

Russia’s economy is majorly dependent on its oil exports. As oil prices fall Russia is
increasing oil production to maintain its normal level of incomes. Russian firm
continue to increase output since a weaker domestic currency has protected their
business. Moreover, a new tax regime in Russia could ultimately lead to a further
increase from oil fields in western Siberia. The depreciating Russian currency cuts
costs and taxes, thus increasing the gap between top-line and expenses for the
companies that generate earnings in US dollars but pay most of their expenses in
rubles. Furthermore, Russian energy minister, Mr. Alexander Novak recently
stated that oil production in western Siberia, which was once a major contributor
to overall output, was decreasing at an average rate of approximately 1% per
year. Also, amendments in the tax regime which would tax excess profits at 70%,
which would make western Siberia commercially feasible. According to Mr.
Novak, under the current tax regime oil output of 73 million barrels are not
economically feasible. The Russian energy minister further went on to state that

pg. 13
the change in the tax regime was made in order to render the production of oil
more feasible.
Russian oil output reached recently a record post-soviet output of 10.86mbpd in
late December.

Pakistan’s Economic aspect

After touching the historic price of $108/barrel in mid-2014, oil price fell to $35 a
barrel in both WTI and Brent after spending much of the year below $50/barrel.
According to the head of commodities at citi group, Mr. Ed Morse, oil prices could
fall to a record low price of $20 a barrel in the first half of 2016 before rebounding
back to around $60 in the latter half of 2016.
The downward spiral of oil prices in the international market should be seen as a
blessing for a country like Pakistan that is energy-starved and banks heavily on oil
imports from global markets. It has, however, created nervousness in the
government that sees the fall in global oil prices and other commodities as a
threat to its revenue efforts as the country heavily relies on taxes on international
trade for revenue generation. Pakistan collects 48% of its total revenue by levying
customs duties and other taxes on imports.

The drastic fall in oil prices has shrunk the policy space for the government, which
sees taxes on international trade as an easy and less costly means to achieve the
revenue targets. To meet the targets of the second quarter of the current fiscal
year, the government introduced a mini-budget by raising import tariffs that
included an increase in customs duty and imposition of regulatory duty on a large
number of items. On the import of petroleum products, the government is
continuously increasing sales tax to meet the revenue targets. At present, sales
tax on certain petroleum products is at its historic peak. Some analysts believe
this rate of tax is unprecedented and equivalent to anti-consumption and luxury
tax imposed to discourage consumption of certain products.
Pakistan’s economy has suffered due to increasing costs of energy and petroleum
products. This has created challenges, especially for the export sector, in the
global markets despite the country’s competitive advantage in certain textile
products and agricultural commodities.

pg. 14
A number of economists have empirically proved that the fall in oil prices is good
for economic growth. They developed their models by analyzing the substantial
reduction in oil prices in the mid-80s due to the supply glut. Economic scholars
concluded that a 10% reduction in oil prices could enhance economic growth by
0.5 percentage point.
Pakistan heavily relying on oil imports, gets highly affected with any shift in
international crude oil prices. With the recent declining trend in prices although
the industry gained from the decreasing oil prices, oil importing and oil marketing
companies get adversely affected by this in the form of inventory losses.
The price changes are subject to Pakistan’s petroleum ministry’s decision to
update the change in prices. Oil and Gas Regulatory Authority (OGRA)
recommends the change in prices and it is implemented after the Government’s
approval. The delay caused because of this process leads to huge inventory losses,
and gains in some cases for oil refining and oil marketing companies.

pg. 15
 The Circular Debt Issue

The oil marketing companies sell oil to the IPPs or the Wapda-owned electricity
generation plants (called Gencos) which produce electricity and sell it to the
government-run distribution companies referred to as DISCOs (for example Lesco,
Pesco, etc) which provide power to our homes and factories and bill us for this
service. The tariff (price) at which the Gencos sell to the DISCOs and the tariff at
which electricity is supplied to us consumers is determined by Nepra, after
receiving government approval.
The first problem which results in the receivables not cancelling out payables is
when the tariff is unable to meet the costs of its generation and distribution. For
instance, if the price of oil goes up internationally and tariffs are not revised
upwards to account for this increase, there is an element of subsidy whose cost
the government has to pick up. So one component of what constitutes circular
debt is the lower rate at which electricity is being charged to the consumer than
the cost of its generation and distribution. By failing to foot this subsidy bill the
government builds up the circular debt. The bulk of the issue arising from the
failure to revise tariffs upwards on a timely basis has been resolved; the
remaining adjustment required on this account is Rs100bn for this year, which
also includes the cost of poor governance.
Next, three components, and the most critical ones, which raise costs, and feed
the circular debt, are the following:

1. The inefficiencies of government-owned generation and

distribution companies, cosy deals struck with providers of rental
power plants, overstaffing, free provision of electricity to Wapda
employees (this costs other consumers Rs10 crore a day), poor
maintenance of plant equipment, obsolete technologies (resulting
in technical losses), corruption, all of which simply add to the cost
of electricity that consumers are being constrained to bear with
equanimity through tariff increases.

pg. 16
 2. The massive issue of electricity theft — the cases of DISCOs in
Hyderabad, Peshawar, Quetta and Fata are now well known; with
literally no one paying in Fata.
3. Poor collection of electricity bills. Rs90bn alone is due from
provincial governments. Powerful private individuals and
companies are also defaulters as are those who in collusion with
Wapda employees do not pay without being disconnected —
Rs120bn is due from private consumers!
To summarise, the issues are failures to revise electricity tariffs on a timely basis;
prevent electricity theft; and ensure collection of billings speedily and
disconnecting those not paying their bills; disconnections will actually also reduce
the extent of outages/loadshedding. In other words, the principle issue is that of
governance.
Even after the controversial repayment back in 2013 when the government took
office, circular debt has remained an unbridled threat; and the threat has now
blown into a full-fledged debacle as it is back to high levels. Post the IMF
Programme, not only the circular debt has surged sharply to over Rs300 billion
but its previous settlement (Rs480 billion in 2013) has also come under the
scrutiny and objection for alleged transgressions.
Apart from finished payments under the IMF Programme, the growth in circular
debt has come primarily from the non-fulfillment of dues from the independent
power producers, low recoveries of bills and persistently high transmission and
distribution losses all of which have persevered despite tall claims. Also, the non-
payment of subsidy claims has been causing disturbance to the flows of the IPPs
and fuel suppliers like PSO.
Because of its size and contribution to the market, Pakistan State Oil (PSO) is the
first player to feel the tremors under such conditions. The oil marketing giant has
time and again yelped for governments help to come out of the liquidity crisis.
Once again, the OMC has raised the white flag signaling the possibility of a
default.

pg. 17
 Oil price and monetary policy

It is always a challenging situation for monetary authorities to overcome the

recession as a result of oil price shocks. A tight monetary policy may moderate
prices but at the cost of production losses. Change in interest rate operates
through the demand channel, a higher interest rate would encourage people for
savings and aggregate demand may fall. Prices will also fall and firms will lower
output intensifying the recession. On the other hand, a loose monetary policy
might lessen the production losses but it would boost inflation in the economy.
When the interest rate is decreased by monetary authorities, people have lesser
incentive for saving. For empirical analysis, only one study is available for Pakistan
which quantifies output loss associated with oil price shocks and a resulting tight
monetary policy. It asserts that an oil price shock contributes just 17% in
recession whereas 83% in recession is contributed by a resulting tight monetary
policy. Furthermore unearths that monetary policy in Pakistan does not following
any rule whereas a rule based policy can bring better macroeconomic discipline.
At present, Pakistan lacks clearly specified rules to make monetary policy more
responsive to output losses. This briefly investigates the optimal change in
interest rate due to oil price shocks. It quantifies the impact of different changes
in interest rate on macroeconomic variables and takes the help of the rule to
achieve this end.
Even developing countries will get benefit from the fall in oil prices. The oil bills
constitute the biggest item in the import list of Pakistan, thereby disturbing the
balance of payments. Also, rising oil prices over the post 2008 era emptied
Pakistan’s foreign reserves and impacted the price of the rupee, which was
declining against the dollar.
Pakistan has been considered a petroleum province since long, the first well was
discovered in 1866 at Kundal in the upper Indus region. After the independence in
1947 there was a need for the legal framework in the petroleum upstream sector
and in 1949 Pakistan. In Potwar where production declined very rapidly. The
drilling activities by other foreign oil companies were also unsuccessful.

pg. 18
 • The private companies made the initial discoveries; in the early
1960s
• OGDCL was created which developed a successful track record in
discovering oil.
• Following the oil crises in 1973 number of impressive discoveries
were made both by private sector and OGDCL.
In order to remain attractive in highly competitive global exploration market, the
Government has been making progressive changes in the investment policies and
regulations at regular intervals. With first E&P policy of 1991, Pakistan caught the
attention of international petroleum industry and further subsequent
improvements through policies of 1993, 1994, and 1997 made Pakistan an
attractive location for upstream investment. Pakistan overhauled the policy in
2001 and introduced corresponding regulation in 2001 for onshore areas and in
2003 for offshore areas.
The government was slow in making a policy for this sector because previously
government felt that there was less need to priorities this sector given that cheap
imported oil was available. However in 1980s due to increased oil prices,
government in 1991 gave its priority to this sector by launching first petroleum
policy in 1991.

pg. 19
 The Case of Liquefied Natural Gas

Following this global trend, the Government of Pakistan was also seeking LNG
imports, but the question was, at what price? Pakistan was leaning towards Qatar
to import 500 MMCFD4, and initial quotes of price were around $17/mmbtu,
excluding cost of regasification, shipping and other logistical concerns. The
Ministry of Petroleum and Natural Resources (MPNR) aims to increase the volume
imported by 2BCF/day in the next two years5. Pakistan seeks to import 2BCF/day,
which would amount to about 730BCF/annum. This means that Pakistan would be
the third highest consumer of LNG. A pertinent fact to note in this context is that
Asia makes 68% of the market share of LNG imports, and the share is continuing
to increase. In the future, Asia must make the most of its significant market share
and employ collective bargaining power towards creating a new natural gas
pricing hub in Asia. However, although Asia makes up a significant share of the
LNG, it has not been able to influence LNG pricing from Qatar significantly.
Though it has varied from country to country, and the pricing mechanism is
largely dependent on the prevailing market price in the region. The export-landing
price of LNG from Qatar8 to various countries is shown in the table below,
reflecting a precedent of low LNG price of long-term agreements:

LNG Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13

Prices
from
Qatar
Taiwan 12.6 13.04 11.33 12.78 10.9 12.62 11.84
India 11.66 11.68 10.48 11.05 10.97 10.61 11.47
Source: Pakistan Energy Book 2012

India’s LNG price from Qatar in the period of October 2012 to July 2013 has
ranged between $10-12/mmbtu, and the price that did not rise to more than
$11/mmbtu in 2013.

pg. 20
 The price of LNG may be the single biggest factor impacting economic activity in
Pakistan. A look at the major gas fields of Pakistan (see table below), constituting
almost 85% of total production shows that domestic gas was no more than
$4.78/MMbtu

Table: Major Gasfields in Pakistan with prices in $/MMBTu

Gas Field Sui Zamzama Qadirpur Mari Bhit Sawan Uch Manzalai Kandhkot

MMCF/day 562 507 496 495 385 317 185 169 164

$ per 2.0 4.36 2.8 0.74 4.7 4.45 3.9 2.87 2.11
MMBTU
Source: Pakistan Energy Book 2012

Qatar is a brotherly nation, a Muslim country with which Pakistan enjoys good
diplomatic relations. Additionally, it is an important trade partner (USD 15802000
of Pakistani exports to Qatar for 2013-14), with Basmati rice and meat
constituting some of Pakistan’s major exports to Doha. Citing difficult economic
conditions and extenuating circumstances. There has however been much
controversy on this matter, as analyst believe importing from a relatively closer
country would’ve have save billions of rupees. Analysts have claimed that the
tender offer from Saudi Arabia was much lesser than Qatar but was not done due
to political reasons.

pg. 21
 The case of Compressed Natural Gas

In the late 2000’s CNG became a popular option amongst consumers while the
sale of factory fitted vehicles also increased. CNG stations started opening across
the country as the government made the process of obtaining a license for a
station easier. Tax concessions were also granted on importing CNG kits and
equipment. Billions of rupees were invested in the CNG industry and seemingly
everybody was happy. However, those halcyon days would not last as it emerged
that the country’s gas reserves were not as plentiful as imagined. Gas was limited
and it had to be fairly rationed for all sectors, such as domestic users and industry.
Motorists began to feel the crunch, and the present government began to reverse
the Musharraf-era policy. It was announced in 2011 that the government was
considering limiting the usage of CNG by private vehicles while encouraging its
consumption by public transport. Some major manufacturers stopped taking
orders for factory fitted CNG vehicles.
It appears as if the Musharraf government’s policy was not sustainable. The
state’s planners perhaps at that time did not realize that CNG would become a
highly popular fuel with motorists, primarily due to its lower price. Both petrol
and diesel crossed the psychological barrier of Rs100 a liter, while CNG is retailing
for over Rs80 per kg.
It is said CNG’s share in national gas consumption is only eight per cent. Some
critics were of the opinion that the pricing of all fuels needs to be rationalized and
brought at par in order to create a level playing field and to ensure there is not
over-consumption of a particular fuel.
Pakistan is facing an energy shortfall of 19777.988 (KOE). This shortfall may
aggravate in future, if rational policy decisions with prudent use of energy
resources are not taken immediately. It is highly tilted towards natural gas, which
constitutes 49.5 percent. This share of natural gas has been supplied from
country’s own resources for its usages in power generation, domestic,
commercial, industry and CNG-fitted transport usage. Irrational policy decision
was the promotion of CNG sector. Pakistan is the leading CNG-fitted vehicles user
in the world. The sector consumed 0.1 percent in 1997 and now it gets about 9

pg. 22
percent share of natural gas. The country witnessed an extraordinary growth in
the sector, and the reason could be attributed to price differential and
government’s policy to promote more cleanly and environmental friendly energy
usage, and to slash oil import bill. The ill-planning and future short-sightedness of
policy planners has resulted into natural gas load-shedding in the country.
Provision of gas to CNG sector at the cost of other value adding sectors has
hampered the growth prospects of the country and also unrest among the
populace. The closure of CNG stations, especially in winter season, strikes by
commercial vehicles owners and grievances of domestic gas users have almost
become a daily affair.

pg. 23
 Petrol Pricing Formula
Consumer prices in Pakistan are made up of the following elements:

• Ex-refinery price based on concept of "Import Parity"

• Government levies (excise duty and Petroleum Development
Levy)
• Inland freight
• Distributor and dealer margins
• Sales tax
The Ministry of Petroleum has approved the pricing mechanism. Each of the
above elements have been explained below:

EX-REFINERY PRICE:
The ex-refinery price of a product, which is paid to local refineries, equates to the
landed cost of the product. In other words it relates to the import parity price of
the product if the same were to be imported. The base price relates to the
relevant product's FOB price averaged for the fortnight as quoted in the Arab Gulf
region to which are added other elements like freight, duties, L/c and bank
charges, custom duty, wharfage etc to arrive at the refinery price.

GOVERNMENT LEVIES:
Government levies are the prerogative of the Government and are fixed in
accordance with the needs of the Government. Petroleum products are an
important source of any Government's revenue and Pakistan is no exception.

pg. 24
INLAND FREIGHT:
Inland freight is used to equate the prices of the products all across Pakistan. In
order to do this:
29 core depot locations have been identified and prices are kept constant over
these locations.

• The product wise cost of product transportation from refineries or

imports to these 29 locations is allocated to the respective
product and is called primary transport cost.
• Primary cost represents actual cost and does not include any
profit element for the marketing companies.
• The cost of transporting product from these aforementioned core
29 depot locations to the respective retail outlet is called
secondary transport cost and varies in accordance with the
distance of the retail outlet from the nearest depot. This cost is
over and above the maximum ex-depot sale price determined by
OCAC for the 29 core depot locations.
DISTRIBUTOR AND DEALER MARGINS:
The Government fixes the distributor and dealer margins, which represent the
profit element for the oil marketing company and their dealers. These margins are
represented as a percentage of the Maximum Ex-Depot Sale Price. From July
2002, these have been fixed at:
3.5% for Oil Marketing Companies and
4% for dealers.
SALES TAX:
Sales tax is the last element in the consumer pricing and is calculated at 15% of
the price before sales tax.
A sample calculation sheet for working out the ex-refinery prices of various

pg. 25
 Conclusion

GDP growth is regarded as the driver of oil demand besides its price. It has the
tendency to reduce vulnerability as the share of oil imports decline as income
rises. But this is possible only when the GDP is on the path of sustainable and long
term growth. Sustainable growth is possible when there is a growth in the real
sectors (manufacturing in particular).
The government of Pakistan has not taken significant measures to reduce the
reliance of oil to be imported rather than explored domestically. With several
studies proving a large amount of oil reserves in Pakistan, and the potential shale
oil reserves should have been utilized in the past, which would have helped to not
only improve the domestic market, but would have played a catastrophic role in
curbing the circular debt issue. However right Pakistan seems to be moving in the
right direction as the government has been encouraging OGDCL to experiment
with new projects, which includes digging to explore shale oil. This coupled with
the addition of new IPP’s through CPEC, and better recoveries from DISCO’s
should reduce the circular debt and strengthen the overall petroleum sector.
The low oil price might not be much attractive for the OMC’s but it is definitely a
new ray of hope for the domestic producers who now enjoy a significant
reduction in the cost of production. It is pertinent to note that the impact of the
decline in oil prices could have been used to even better effects had the policies
been quick and appropriate, but nevertheless a relatively stable outlook of oil
prices (predicted by OPEC) means that revenue streams in the coming years
would be much more stable.

pg. 26