Abstract

The aim of this paper is to understand the effects of the rising Price of Oil, and its
consequences for the Developing world. Escalating prices of this precious
commodity has led to devastating effects across the globe, but the severity of its
consequences is most prevalent in the emerging markets arena. The longest growth
spurt in the history of Pakistan has paved the way for the severest recession the
nation has ever experienced. High oil prices, political turmoil, and high levels of
inflation are all leading to an era of economic uncertainty. The Macroeconomic
effects of the Rising oil prices have affected the nation with great intensity. The
lasting solution to the problem of imported oil for Pakistan is rapid development of
alternative energy. Pakistan is already a pioneer in the use of Natural Gas as a
primary source of energy, and further development will only lead the nation towards
energy independence.

Key Words; Oil Prices, Inflation, Consumption, Trade Deficit, Economic Growth,
CNG.
 Outline

1. Introduction

1.1 The Global reaction to rising Oil Prices

1.2 Oil Prices hit the Emerging Markets

1.3 Introduction to the Economy of Pakistan

2. Review of Literature & Empirical Analysis

2.1 High Oil Prices and Economic Growth

2.1.a. Macroeconomic Issues

2.1.b. Monetary Policy for an Inflationary environment.

2.2 The Dynamics of the Current Economic problems of Pakistan

2.3 Oil Prices and Inflation & Oil prices and Trade Deficit-Introduction to the
Macroeconomic Model

3. Data Modeling & Empirical Analysis

3.1 Oil Prices and Inflation & Oil prices and Trade Deficit

3.2 Oil prices and substitution with Natural Gas.

4. Empirical Results

4.1 Price of Oil and National Income Accounting

4.1.a Rising Value of Imports

4.1.b Rising Inflation

4.2 Real Affect of Rising Oil Prices on Pakistan.

4.3 Natural Gas as a Solution

4.3.a The CNG Sector

4.3.b The Independent Power Producers (IPP)

4.4 The disadvantage of substituting Fossil Fuels

4.5 Price of Oil and the Demand for Natural Gas, introduction to the model.

4.6 Price of Oil and the Demand for Natural Gas, model tested.
 5. Conclusion

6. Bibliography

1. Introduction
1.1 The Global reaction to rising Oil Prices

After hitting fresh records almost every day prior to July/18/2008, the price of oil has
fallen, but not enough to ease the growing global epidemic of inflation that high oil
prices have brought. The world today is more dependent on oil as a source of
energy than it ever was before. This is not the first time global economic leaders are
facing the issue of higher energy prices, and rising rates of inflation, but it is still
creating a wave of uncertainty, which has negatively impacted all major financial
markets of the world. The health of the financial markets is a good predictor of
where the economy is headed. Today most bourses around the world have shown
double digit declines in market capitalization. Economic Leaders in both, the
developed world, and the emerging markets are cracking their heads trying to
figure out how to ease the pain their citizens are facing due to the rising prices of
energy. Higher energy costs are leading to inflation, as all goods and services
require some measure of energy to product, store, and distribute. Higher energy
prices are also lessening the discretionary incomes of consumers as they need to
spend more on energy leaving less available to spend on other goods and services,
therefore negatively impacting consumer spending. As consumers spend less on
consumption they decrease the aggregate level of consumption in an economy,
which impacts total Gross Domestic Product (GDP) negatively.

What is causing this rapid increase in the prices of crude oil? There are many
theories out there trying to explain this phenomenon. One major term is the rapid
increase in demand from the rising “BRIC” (Brazil, Russia, India, and China) nations.
Rapid Industrialization, and economic growth has prompted the BRIC economies to
require a substantial increase in the amount of oil used for energy. The other theory
out there is that the depreciating dollar is making it cheaper for BRIC’s, and other
nations, to buy more and more oil, because crude is quoted in dollars, and a
depreciating dollar is leading an increase in the buying power from domestic
currencies. We also hear that increased speculation in the derivatives markets, has
transformed this conventional hedging marketplace into a gambling arena, where
speculators use margin accounts to buy futures contracts of crude oil hoping to
make a profit and sell before contract maturity. The speculators can manipulate oil
prices by buying or selling many contracts simultaneously creating greater market
volatility. It cannot be certain which one of these variables is most effectively
changing the price of crude oil each day, but for now the consequences of this run
up from $27 per barrel in 2003, to over $140 per barrel in 2008, has a very sour
outlook for the global economy.
Why does the price of Oil effect the growth of the global economy? The main reason
is that a large amount of oil reserves that remain today are located in areas where
the consumption is low due to lower populations (the Middle East, and northern
Europe). This makes the more populated nations net importers of oil, and increased
prices leads to increased import bills, which affect a host of other macroeconomic
fundamentals of oil-importing nations’ economies.

Source: ReutersQ-Charts

1.2 Oil Prices hit the Emerging Markets

The effects of the rising price of oil and its negative externalities can most notably
be seen in the current severe economic slowdown in some parts of the developing
world. The developing nations historically have been a place where economic
growth has remained robust even in the most uncertain of times. Today the picture
looks much different as rising costs of energy is leading to higher production costs,
and higher transportation costs for all goods and services in the economy. Producer
price indexes (PPI), measures the change in prices that producers face as a as a
result of rising costs, and because of rising oil prices many nations have steeply
increasing PPI’s. Producers pass down part of their rising costs to the consumers,
which increase the shelf price of goods and services driving up the index of
consumer prices (CPI). Inflation is not the only concern facing policymakers in the
emerging markets, because most of the oil these growing economies use is
imported, the rise in the price is leading to hefty import bills contributing to rising
trade deficits. Trade deficits are not necessarily a negative outcome, but a growing
trade deficit can lead to more macroeconomic issues in the long run.
 The biggest problem with rising prices of imported oil is that prices are rising at a
rate at which none of the central banks across the world expected, and this is
adding the huge amounts of money on every nations import bill. Unexpected
inflation, due to the rise in costs of production, and transportation because of the
rise in energy costs- primarily imported oil- leads to imported inflation in the
domestic markets. In countries where the elasticity of demand for imported oil is
relatively inelastic (i.e. 0<d<1) there is a greater effect on the macroeconomic
stability of that economy. Economies that are most affected by this run in oil prices
are ones where the percentage of GDP spent on imported oil is higher than that of
other nations where the percentage of GDP spent on imported oil is lower. The
percentage of Gross Domestic Product (GDP) spent on imports, and more
specifically on oil imports, varies drastically. Well developed industrialized nations
tend to have a higher nominal GDP corresponding to a lower percentage of that
spent on imports. Countries where the nominal GDP is very low, a greater
percentage of that national income is spent on imported oil, given similar population
demographics, all other things the same.

1.3 Introduction to the Economy of Pakistan

Pakistan is amongst the major developing economies of the world. With a

population of over 150 million, it is also one of the most populous countries in the
world. Pakistan is a major trading partner to all developed nations of the world,
including the U.S., U.K., France, Germany, U.A.E., and Saudi Arabia. Political
uncertainty, social issues, and corrupt governance have delayed steady economic
growth in the 61 years of Pakistan’s existence. This has not necessarily been the
case for the past 7 years- as the following indicators suggest- a prosperous
economic future was in sight, but the current global dilemma of increasing oil prices
has turned the tables quickly.

The economy of Pakistan has experienced some unprecedented levels of economic

growth in the past 6 years. The growth has remained above 6% per annum Year
over Year (YoY) since 2003 to 2007. The foreign workers’ remittances have grown at
an exponential rate, showing signs of confidence in the economy, by Pakistani
expatriates. Inward foreign investment both Foreign Direct Investment (FDI) and
Foreign Portfolio Investment (FPI) have grown substantially. The foreign exchange
reserves have steadily grown from $2 Billion in 2001, to over $14.5 billion1 in 2007.
Pakistan’s largest stock exchange index, Karachi Stock Exchange-100 Index (KSE-
100) has steadily grown from 890 points in 1998, to over 15,0002 points ( Jan-2008).
Inflation has stood steady at approximately 9% per annum from 2000-2007. All of
these factors combined have fueled the largest ever economic expansion in
Pakistan’s history.

1
Federal Bureau of Statistics www.statpak.gov.pk
2
Karachi Stock Exchange www.kse.com.pk
The picture is not as perfect as it seems, because all these numbers show the
growth rate till the end of 2007. This year the scenario is much different. The
economic growth rate has slid into negative territory in real terms. Inflation has
risen to double digits, and the trade deficit has steadily risen to the highest level in
Pakistan’s history. High oil prices have led the government to reset the subsidies on
oil that the previous administration had levied. This has led to an increase in the
retail prices of petroleum products by over 49% since Jan/2008. The increased
prices have translated into higher prices in the broad economy. The Average (YoY)
CPI has jumped up to 17%. The largest increase within the CPI was the increase in
prices of food and energy, which have risen by 34.91% and 24.51% respectively.
The rupee has depreciated versus the US Dollar by more than 14% since Jan-2008,
leading to a capital flight, as more and more investors pull money out of the
Pakistani economy, fearing further deterioration of the financial stability. The KSE-
100 index has slid from a high of over 15,000 points, to a low of 10,000 points (Jun-
2008).

What consequences do rising prices of oil fueling economic instability have on the
economic future of Pakistan? First, this rise in oil prices is leading to huge increase
in the PPI, and CPI, leading to higher levels of inflation. Second the rising trade
deficit is growing and adding to an already hefty import bill which is being financed
by national exchequer. The current trade deficit is greater than 12% of total GDP.

Introduction to the Alternative to oil in Pakistan: Natural Gas

There is one positive result of the rising price of oil; the rapid development of
alternative sources of energy. The rising price of oil has prompted the government
to launch many initiatives on the development of alternative energy, but the most
successful of these has been Compressed Natural Gas (CNG). Pakistan has become
one of the largest users of Natural Gas a primary energy resource. In addition to the
rising consumption of Natural Gas in the industrial, commercial, and agricultural
sectors, Pakistan has now become home to the world’s largest fleet of Natural Gas
Vehicles (NGV). The transportation sector has seen exponential growth in Natural
Gas consumption, as the number of CNG powered vehicles has risen from less than
10,000 in 2002, to over 1,500,000 by 2007. The number of Compressed Natural Gas
filling stations has also increased exponentially from less than 20 in 2001, to over
1,500 in 2007. Independent Power Producers, which provide 35% of total energy to
all other sectors of the economy, are swiftly shifting their oil based power
generators to natural gas based generators to ease the burden of rising oil prices on
the economy.

Why does Natural Gas seem to be a better option to substitute one fossil fuel with
another? The most simple and obvious argument would suffice for this scenario;
natural gas is cheaper than crude oil in the World markets, there is a substantial
amount of supply available in Pakistan eliminating the need for importing energy
raw material, and it is cleaner for the environment.

2. Review of Literature & Empirical Analysis

2.1 High Oil Prices and Economic Growth

2.1.a. Macroeconomic Issues

The energy sector of Pakistan is comprised of a unique mix of resources. In my

review of the literature for this research, I came across these facts regarding the
energy sector in Pakistan and its sensitivity to the rising prices of crude oil.
According to Malik (2008), the growth in demand for petroleum products in Pakistan
has been growing at a negative rate. The current volume of imported oil has been
steadily increasing at a negative rate, but the dramatic increase in the price of oil
has led the value of those imports to rise exponentially. The study further shows
that as the rise in the price of oil started in early 2003, Pakistan’s economy steadily
grew at a rate of over 6%. This negates the conventional direction of the economic
growth when price of oil rises. An upward trend in the price of oil usually squeezes
income, and demand, Leading to less consumption, and lower corporate earnings,
leading to lower economic growth. The scenario of rising oil prices, and economic
growth were fueled by the monetary expansion that took place in most nations
across the world between 2002 and 2006.

The following illustration shows the negative impact when the monetary expansion
measures had cooled down (2006-present), squeezing the amount of money in
circulation; the GDP growth rate slid. Beginning in 2005, the economic growth rate
has grown at a decreasing rate, citing the effects of the rise in prices of imported oil
as a primary cause.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Rising prices of imported oil have increased the amount of foreign exchange
reserves required to finance the purchase of the oil. As the price goes up, the
foreign exchange reserves go down, and the value of debits rise on the current
account of the nation’s trade balance, leading to a trade deficit. A very large trade
deficit can cause the value of the domestic currency to drop as a measure to
increase the competitiveness of local exporters to offset the growing trade deficit.
Depreciation in the local currency has its own negative effects, as it results in lower
returns, and net capital outflows, as investing in a country where the currency is
falling in value leads to higher foreign exchange risks. Lower capital means lower
investment spending, thus weakening the local economy further.

2.1.b. Monetary Policy for an Inflationary environment.

In a study by Khan and Schimmelpfennig (2005), the correlation between an

expansionary monetary policy and rising inflation are very strong. Meaning if the
government tries to expand the money supply it will surely meet inflation as a
primary consequence. The significance of this study for our purposes is that in the
period preceding the current oil price crisis, we had the largest credit expansion all
over the globe. The economy of Pakistan experienced an average of a 22% increase
in broad money and 30% increase in credit growth between 2004 and 2006.
Although expansionary monetary policy does aid inflation, the effects of a growing
money supply between 2004- 2006 have been minimal in raising inflationary
pressures in Pakistan. As the following illustration suggests, expansionary monetary
policy had been implanted as early as 2002, but CPI did not start rising till as late as
early 2008. This picture looks very similar to the illustration depicting the rise in the
price of oil. Beginning 2007, the rise in the price of oil resulted in higher inflation
rates in Pakistan.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

2.2 The Dynamics of the Current Economic problems of Pakistan

Looking at the table below, the industrial sector and the transportation sector are
the two largest components of total energy consumption in Pakistan. A rise in the
Price of Oil, by 100%, led to an increase in demand for oil by 19% over the period
between 2003 and 2007. This denotes a low price elasticity – the percent change in
quantity demanded/consumed, divided by the percent change in price- meaning the
demand for oil in Pakistan is relatively inelastic to changes in Price.

Price Elasticity = 19%/100%= .19 ; Relatively inelastic.

Change in Oil Consumption with Change in Price

 2003-2004 2006-2007 Change Percent Change
Oil 15,221,024 18,120,837 +2,899,813 +19%
Consumption(TO
E)
Price of Oil ($) $32.00 $64.00 +$32.00 +100%
(annual average)
Source: Hydrocarbon Development Institute of Pakistan.

Total Energy Consumption by Sector (metric Tonne)

Total Energy Consumption by Sector 2003- 2006- Change Percent
(metric Tonne) 2004 2007 Change

Domestic 6,278,918 7,605,145 +1326227 +21.1%

Commercial 851,857 1,377,247 +525390 +61.7%
Industrial 11,098,642 15,792,049 +4693407 +42.3%
Agriculture 734,202 767,266 +33064 +4.5%
Transportation 8,771,365 9,721,183 +949818 +10.8%
Total 27,734,98 35,262,89 +7527907 +27.1%
4 1
Source: Hydrocarbon Development Institute of Pakistan www.hdip.gov.pk

The low price elasticity tells us that as prices rise there is limited or no effect on
demand, thereby increasing the Dollar amount of quantity consumed. This means
the total effect on the nations import bill consists of the 100% increase in price of
oil, in addition to the 19% increase in oil consumed.

Looking at the picture below, the domestic production of oil is very limited in
Pakistan, and more than 85% of oil is imported today. This picture shows changes in
amount of oil consumed, but the issue here is the price of oil, although the barrels
of oil consumed each day have increased at a marginal rate between 2002- and
2006, the price has gone up by more than 100% as shown earlier. The numbers
today are even higher (est. 2008). The difference between the consumption and the
domestic production of oil is adding to the import bill of Pakistan leading to a
growing trade deficit.
The Balance of Payments of Pakistan has shown a growing trade deficit for the past
6 years. Looking at the picture below the trade deficit stood at approximately $5
Billion in 2005, and has grown to over 20 Billion as of 2008. This rise is further
deteriorating the macroeconomic fundamentals of the nation.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

2.3 Oil Prices and Inflation & Oil prices and Trade Deficit-Introduction to
the Macroeconomic Model

Finally, economic model that explains the effects of rising oil prices on the economy
of Pakistan is as follows, as the price of oil goes up, the value of imports rise,
causing a negative impact on the trade deficit. The other more significant effect of
rising oil prices is increased inflation due to the rise in costs of imported oil, leading
to the rise on production, transportation, and all other energy costs faced by
producers, and consumers. Higher Consumer Inflation leads to lower discretionary
income left with consumers to buy other goods and services which decreases total
consumption in an economy leading to slower economic growth. When inflation gets
out of control central banks usually tighten the money supply which can contract
the economy even further.

The main issue is the effect of rising prices on the national economy and the
changes it brings within the economic model. Rising prices of oil are causing
increased unanticipated inflation, and lower economic growth hence impacting the
economy negatively. This can be shown through a simple macroeconomic model of:

GDP = Y = C + I + G + (x-m) , where

C= consumption, I= investment spending, G= Government Spending, x=

exports, and m = imports.

As price of oil goes up, inflation kicks in as price of every item in the basket of goods
rises (virtually all items need some form of transportation or storage exposing them
to the costs of energy). The increased prices lead to lower discretionary incomes
leading to less C (consumption), decreasing the total amount of Y(GDP).

The other effect of rising oil prices is that as oil prices go up, an economy importing
majority of its oil, will see a rapid increase in the value of m(imports), leading to an
increased trade deficit, hence lowering the trade balance, or creating a trade deficit
which will result in lower Y (GDP). Both these cases will be further developed in
section 4, using actual statistics.
 3. Data Modeling & Empirical Analysis
The data used to prepare this paper, is derived from a variety of sources, including
working papers, and Government organizations. The modeling consists of simple
use of economic tools to analyze the impact of oil prices on the economy of
Pakistan.

The numbers and statistics used all are recent most figures obtained from the State
Bank of Pakistan, Federal Bureau of Statistics of Pakistan, Hydrocarbon
Development Institute of Pakistan, the IMF, the World Bank, and The Asian
Development Bank(ADB). All figures used are at calculated at current price levels,
and the percent changes are calculated on a YoY basis.

The methodology used to determine the level of Gross Domestic Product consists of
the expenditure model. The whole is divided into 2 sectors according to the official
Federal Bureau of Statistics division in Pakistan; Production Sector, and Service
Sector.

The Production Sector consists of total expenditure in Agriculture, and Industry.

According to the national accounts the Agriculture industry in the production sector
includes crops, livestock, fishing, and forestry. The Industrial sub-section within the
production sector consists of mining & quarrying, manufacturing , construction,
and electricity & gas distribution.

The Service sector includes expenditure in transportation, wholesale & retail trade,
finance & insurance, ownership of dwelling, public administration & defense, and
community, social & personal services.
 4. Empirical Results
4.1 Price of Oil and National Income Accounting

Examination of the analytical model as mentioned above very similar results as to

what actually happened in Pakistan during the period when oil prices rose
exponentially. To do this, I am going to use the numbers from the following tables
showing the GDP (Y) of Pakistan, the total Consumption Expenditure I, Investment
(I) & Government Spending (G), and the net Exports (x-m).

GDP at Current Prices (2008)

USD $ (BILLION) 2003 2004 2005 2006 2007 (est.)2008

Consumption( C ) 66.10 78.00 91.85 107.30 120.00 129.78

Investment &
Government
Spending ( I + G ) 13.60 15.58 20.67 27.10 32.35 35.46

Exports ( x ) 10.65 11.25 13.78 15.63 16.05 16.85

Imports ( m ) 11.52 14.29 19.48 27.66 29.50 37.44

Balance of Trade
(x–m) (.87) (3.04) (5.70) (11.97) (13.45) (20.59)
GDP ( Y )
= C+I+G+(x-m) 78.83 90.54 106.82 122.43 138.9 144.65
GDP Percent
Change(YoY)% - +11.71 +17.9 +14.6 +13.5 +4.1%
Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

4.1.a Rising Value of Imports

As you can see, the numbers tell us nothing other than the GDP, at current prices
has been steadily growing. The issue arises when we look at the change from one
year to the next. For example comparing the balance of trade between 2007 and
2008 shows that the rate at which the trade deficit increased was (20.59-
13.45)/13.45 = 53%. Taking any year for example 2007, if we examine the numbers
it is: Y=C+I+G+(x-m), so Y= 120+32.35+ (16.05-29.5) = 138.9 ($BILLION)
>>**(I+G)=32.35**<<

In 2008 the value of m increased, leading to a negative effect on the growth of Y.

Unexpectedly the value of imports rises to 40($BILLION). The GDP rose but a
decreasing rate

Y=129.78+35.46+ (16.05-40) = 140.65 ($BILLION)

>>**(I+G)=35.46**<<

GDP growth rate fell from 17.9% (YoY) in 2005, to 4.1% (YoY) in 2008
(est.).

Meaning a rise in the value of imports at any given time will result in a fall in the
growth rate of Gross Domestic Product, in nominal terms. Assuming oil is
predominantly imported in Pakistan, the rise in the price of oil, will increase the
value of imports (m) leading to a negative impact on the growth rate of national
income(Y).

The other impact of rising prices of imported oil translate into a growing trade
deficit which depicted earlier shows the growth of imports much higher than the
growth of exports. Examining the table above, exports have grown by 7.8%
between 2006 and 2008, while imports have grown by 35.3%.

4.1.b Oil Prices, Inflation, and lower GDP growth.

Increased imported oil prices cause inflation, as the costs of production, storage,
and distribution rise (assuming oil is a major source of energy in the economy).
Increased inflation lowers the buying power of consumers in addition to lowering
discretionary income left (after buying more expensive energy) with households to
spend on other goods and services. This leads to lower growth in consumption
spending, further weakening the economic outlook of the nation. The following table
shows that although total consumption spending has been growing, the (YoY)
change in percentage terms is declining in Pakistan. Proving that higher oil prices
are leading to lower economic growth, as lower growth in consumption ( C ) means
lower growth in GDP ( Y ). In addition to lower consumption growth, higher growth in
imports (m), are further deteriorating the situation as shown earlier.

Consumption Spending Growth (2005-2008)

Consumption( C ) US$ in Billions Percent Change

2005 91.85 -
2006 107.30 +16.8%
2007 120.00 +11.8%
2008 125.78 +4.8%
Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

The CPI data which follows shows the rapid increase in the Consumer Price Index as
a direct result of the rising price of oil.

Consumer Price Index (2004-2008)

Consumer Price Percentage Percentage Change

Index(YoY)
2004 4.57 -
2005 9.28 +103%
2006 7.92 -14.6%
2007 7.77 -1.8%
2008 18.29 +135%
Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

4.2 Real Negative Affect of Rising Oil Prices on Pakistan.

So the rising price of oil has had 2 major affects on the economy of Pakistan.

Effect 1. Increased value of imports (m), have led to decreased GDP

growth rate.
Increased prices of imported oil have also brought Inflation which has decreased
buying power of money, and increased the energy costs of consumers and
producers resulting in lower discretionary spending.

Effect 2. Lower discretionary spending has contributed to the

declining rate of
consumption growthth ( C ) lowering GDP growth rate
further.

Illustration of Effect 1. And & Effect 2.

Effect 1

Increased Imports have led to the a decreased trade balance or an

increased trade deficit as follows. I
Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Effect 2

Increased imported energy prices have led to increased prices at home

leading to increased inflation. Increased inflation has decreased the
discretionary income of households, leading to decreased discretionary
spending. Decreased discretionary spending has resulted in slower
consumption growth.
Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Higher Inflation = Lower Consumption Growth as follows:

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Lower Consumption growth, and higher trade balance result in decreasing
economic growth depicted as follows.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

4.3 Natural Gas as a Solution

The advantages of Natural Gas as a substitute for Oil are quite apparent in the
Pakistani economic framework. The government is offering simple price incentives
for the use of Natural Gas as opposed to oil for consumers in the transport industry;
mainly private and commercial vehicles. The other incentive is for Independent
power producers (IPP) to switch their power production methods from oil powered
pants to gas powered plants. IPP’s contribute to about 35% of the nations’ total
power production, and about 59% of total non hydroelectric power.

Power Generation by Type of Producer ( MW)

Power Generation 2008

Existing Generation
Hydroelectric 6444
GENCOs 3580
IPPs(Independent Power Producers) 5541
Rental 285
SPPs 53
Total 15903
Source: Private Power and Infrastructure Board of Pakistan.
www.ppib.gov.pk

The Natural Gas prices are kept low due to the abundance of local supply in the
Pakistani markets. The two primary sources of natural gas are The Sui gas field in
the western province of Baluchistan, and the Kandkhot Gas Field in Sind. Both these
gas field produce over 50% of the total Gas production in the nation. The other
50%consists of more than a dozen small to medium size gas field across the nation.
Currently Pakistan does not import natural gas. Domestic production is sufficient to
meet the current demands. Rapid investment in the Natural Gas sector has led to an
increase in the number of Natural Gas Vehicle’s on the road. This significantly
releases the economic burden of buying expensive foreign oil for the transportation
sector. Pakistan has over 1.6 million NGV’s which makes it world’s largest fleet of
CNG powered vehicles. The benefit for substituting a conventional gasoline powered
vehicle with a natural gas vehicle is the simple price advantage that the
government has maintained. The current cost of Compressed Natural Gas (CNG) per
Gallon of Gasoline Equivalent (GGE) is $1.36 (approximately Rs. 97.76), and the cost
of regular gasoline $4.12(approximately Rs. 292.50) per Gallon. The effects of this
huge price differential can be seen in the following illustration depicting the change
in the consumption of energy by sources. As a percentage of total energy
consumption in Pakistan, natural Gas now stands at 48%, and oil is down to 29% of
total energy consumption. In 2001, oil consumption contributed to more than 45%
of total energy consumption, and gas stood at 33%.

Total Energy Consumption in Pakistan (sum = 100%)

Source: Ministry of Petroleum and Natural Resources, Pakistan.

The consumption of CNG is on the rise where as the consumption of oil is declining.
Coal and Liquid Petroleum Gas (LPG) is also growing at a marginal rate. This
represents a permanent shift in dependence on foreign oil by the economy of
Pakistan.

4.3.a The CNG Sector

Pakistan has spent more than $1.1Billion in developing CNG sector for the evolution
of the transportation industry. The bulk of it is investment was spent on building
new CNG filling stations. CNG filling stations are similar to gasoline dispensers, but
they require a compressor some place near the dispenser where the natural gas is
compressed to form CNG, which is is filled into the CNG cylinders in the vehicles.
Manufacturing and distribution of CNG conversion kits are another growth area
which has rapidly developed in the past few years to meet the growing demand of
individuals converting their gasoline vehicles to CNG. A CNG conversion kit costs
between $500 and $700, and can easily be installed in any gasoline powered
vehicle in less than 3 hours. After the installation the vehicle is able to run on both
gasoline and CNG.

4.3.b The Independent Power Producers (IPP)

IPP’s play an important role in aiding the transformation of Pakistan from an oil
powered nation to a Gas powered nation. Most IPP’s use conventional generators
that run on oil products such as gasoline, and diesel. The shift lies in investing large
amounts of capital to install gas powered generators in order to reduce the nation’s
dependence on oil, and increase profitability at the same time. The government is
helping speed up the process by offering import incentives on capital machinery
such as zero customs duty, and income tax benefits.

4.4 The disadvantage of substituting Fossil Fuels

The downside exists, that local production of Natural Gas is increasing at a declining
rate. According to official estimates Pakistan will be a net importer of Natural Gas in
the next 10 years in order to meet the increasing gap between supply and demand.
The downside is that all commodities seem to be heading higher in today’s markets
and it seems inevitable that cheap natural Gas will also become more expensive.

The first advantage of making this shift is that the world still has Natural Gas in
Abundance, and according to estimates (by BP world Statistical review) the reserves
of Natural Gas are about 6,233 Trillion Cubic Feet. Dividing that number by 127.8 =
48.8Trillion (GGE). That is equivalent to 1.161 Trillion Barrels of Oil.

The advantage Pakistan still has is the fact that it will be amongst the first to
demand such large amounts of natural gas, so it can secure its supply, by ensuring
deals with governments of nations with abundant natural gas. Iran, and Qatar, both
have tremendous amounts of proven natural gas reserves, and Iran is on the verge
of completing a deal to build a gas pipeline across Pakistan, to India, offering Gas to
Pakistan at discounted rates. Both nations are in close proximity to Pakistan giving
the nation a locational advantage to ensure speedy delivery of natural when the
nation begins importing.

4.5 Price of Oil and the Demand for Natural Gas, introduction to the
model.
The rise in the price of oil has led to expansion in developing natural Gas as a
primary source of energy. The methodology used to determine the benefits of
substituting imported oil with natural gas as primary source of energy in Pakistan is
a very simple deductive economic model of prices. The assumptions here are that
the oil and natural gas are easily substitutable. The availability of both resources is
equally accessible to most consumers, and the simple difference in prices has led to
a substitution by households and producers of oil with natural gas.

As prices of Oil rise demand slows, and supply and all other variables held constant,
the quantity demanded falls. At the same time due the lower price in the natural
gas market, demand increases and all other things held constant, the entire
demand curve shifts to the right. Conventionally this will lead to higher prices of
natural gas but to tackle this the government intervenes by offering a subsidy to
suppliers of natural gas to meet the new demand the supply curve also shifts to the
right eliminating any excess demand, but keeping equilibrium price constant.

Assuming both oil and gas are normal goods, and are primary energy sources for all
three sectors of the economy-namely the industrial sector, the transportation
sector, and the commercial & household sector-and has a normal relationship with
respect to prices (i.e. as prices go up, demand goes down).

Then they will be perfect substitutes if the rise in price of one, leads to a rise in
demand for the other. To examine this hypothetical claim the actual numbers in
Pakistan’s energy sector have to be studied.

4.6 Price of Oil and the Demand for Natural Gas, model tested.

Examining the table obtained from the Hydrocarbon Development Institute of

Pakistan, the demand for natural gas has shown a steep increase in the years 2003-
2008. This increased consumption is the direct result of the rise in the price of oil.
Government initiatives in the form of subsidies have aided the increased use of
natural gas, but majority of the increased demand comes directly as a result of the
increased price of oil.

Change in Price of Oil VS. Change in Gas Consumption

Tonnes of Oil 2004 2005 2006 2007 Percent
Equiv. Change
(TOE) in million’s
(since 2004 in
2007)
Oil Consumption 11.14 11.71 10.87 10.88 -2.3%

Gas 10.01 11.77 13.40 14.90 +48.8%

Consumption

Price of Oil ($) $37.66 $50.04 $58.30 $64.20 +70.5%

Source: Hydrocarbon Development Institute of Pakistan. www.hdip.gov.pk

Consumption of Natural Gas has gone from 10.01(million TOE), to 14.90(million
TOE), where as oil consumption has dropped from 11.14(million TOE) to
10.88(million TOE). The result clearly shows that an increase in price of oil of 70%
from 2004 to 2007, has led to an increase in demand for natural gas by 48.8%, and
a decrease in oil consumption by 2.3%. It’s worth noticing that the increase in price
did not affect demand for oil by a great amount, but it did affect the demand
negatively showing the presence of elasticity even in a product which is relatively
inelastic.

Simple conclusion from this example shows the relationship of both natural gas and
oil being nearly perfect substitutes to each other

5. Conclusion
From the analysis of the price of oil and its consequences for economic growth in
Pakistan, and all over the world, I can conclude that the affects are severely
damaging the macroeconomic stability of all economies which are dependent on
imported oil.

Pakistan is a good example to show how an increase in the price of a commodity

that has a relatively inelastic demand can disrupt the macroeconomic
fundamentals, such as the level of inflation, the growth in consumption, and the
value of imports, and the trade deficit. A growing Negative impact of these
indicators has led to slower economic growth in Pakistan. The major consequences
on the economy of Pakistan have been:

Increased value of imports (m), have led to an increased trade deficit, which has
resulted in a decreased GDP growth rate. Increased prices of imported oil have also
brought Inflation which has decreased buying power of money, and increased the
energy costs of consumers and producers resulting in lower discretionary spending.
Lower discretionary spending has contributed to the declining rate of consumption
growth ( C ) lowering GDP growth rate further.

The positive outcome in Pakistan has been the rapid development of Natural Gas, as
an alternative to imported oil. Natural Gas is produced domestically, and this has
kept the price of natural gas significantly lower than the price of oil in the Pakistan’s
energy markets. NGV’s, and gas powered IPP’s can do much more to transform
Pakistan into a nation run exclusively on natural Gas. Other alternatives to Fossil
Fuels such as Oil and Natural Gas exist in the form of Solar Power, Wind Power, Bio-
Diesel and Geo-Thermal Power, but the capital investment required is very large,
and although current oil prices are shifting attention towards the renewable energy
marketplace, there is still some time before solid steps are taken to take Pakistan
towards complete renewable energy.

6. Bibliography
1.“How Pakistan is Coping with the Challenge of High Oil Prices,” by Afia
Malik, Pakistan Institute of Development Economics

2. “Inflation in Pakistan: Money or Wheat,” by Mohsin S. Khan, and Axel

Schimmelpfennig, International Monetary Fund

3. “Pakistan’s Macroeconomic adjustment and assumption of growth,

1999-2004,” by Henri Lorie, and Zafar Iqbal, International Monetary Fund

4. “Contribution of Workers’ Remittances to the Economy of Pakistan,” by

Zafar Iqal, and Abdus Sattar, Pakistan Institute of Development Economics

5. “Exchange Rate instability and Trade,” by M. Ali Kemal, Pakistan Institute of

Development Economics
6. “Interim Monetary Policy Measures,” by State Bank of Pakistan May 2008

7. “Inflation Monitor,” by State Bank of Pakistan May 2008

8. “Pakistan Energy Yearbook,” Hydrocarbon Development Institute of Pakistan

2007