Lady luck seems to be siding with Naya Pakistan as oil prices have come down to $50 per barrel, and the twin deficit worries have substantially subsided. Given high volatility in the oil prices movement, the gains could be short-lived; and in order to have sustainable advantage, a hedging strategy could be adopted in a few sectors.
One low hanging fruit is to ensure sustainable gas supply to textile exporters in Punjab without incurring fiscal subsidy. With oil down to $50, subsidy on supply of RLNG/System gas to zero rated industry is down to nil, this is right time for the government to hedge oil for next few years and guarantee supply at $6.50 per mmbtu. Once the industry is sure about its energy cost in the long run, the players can expedite the expansion and investment plans.
The government has in principle decided to provide energy at competitive rates to exporters. The formula is to provide either electricity at 7.5 cents/unit or gas at $6.5/mmbtu. It’s better for the country to bring the industry relying on captive generation to grid to dilute the impact of increasing capacity charge on existing consumer; but for that, the government has to incur higher subsidy cost.
On the flip, the industry prefers gas for two reasons – one is that the generating power from its own captive power plants ensures uninterrupted supply, and the other advantage is in co-generation facilities of value added players where they produce steam from residual to process value addition.
Efficiency of captive power plants is around 35-40 percent, for those plants which do not have co-generation facilities or spinning units. However, a large part of the vertically integrated industry has co-generation facilities with which they meet their steam, hot water and chilling requirements – efficiency of such plants increases to 55-65 percent, better than the best IPPs. Plus, there are virtually no T&D losses to make the captive power generation even more cost effective.
Thus, the government has to be selective in allowing captive power generation to those players who are vertically integrated and have, on net basis, better efficiency – there are systems installed to compute the efficiencies at manufacturing unit level.
Anyhow, whichever mechanism the government use for providing affordable energy to exporters -gas at $6.5/mmbtu or electricity at 7.5 cents/unit, the government has to give subsidy, in case of higher oil prices. In existing formula for gas, there is no subsidy required for oil at or below $55/barrel. The calculations are based on gas supply of 205 mmcfd for Punjab industry with 50 percent each coming from system gas and imported RLNG.
The system gas price is fixed at Rs600/mmbtu while the RLNG price gap is to be subsidized, if needed, for mixed price at $6.5/mmbtu. In December, at $75.3/barrel oil, RLNG price (fixed at 13.05% of oil) came at $9.82/mmbtu without any losses provisioning and other cost components.
The SNGPL is recovering $0.96/mmbtu in lieu of T&D losses on supply of RLNG to Industry; although in reality, these losses are nearly zero. If T&D losses are recovered, cost of System Gas/ RLNG supply to exporters can be reduced to $6.00/mmbtu.
With $2.48/mmbtu additional cost (other cost at $1.52 and T&D losses at $0.96), the overall RLNG cost to SNGPL came at $12.3/mmbtu (Rs1,709) in December. The weighted average cost of gas supply to industry is computed at Rs1,154/mmbtu while the government charged Rs903.5/mmbtu or $6.5. The difference of Rs251/unit resulted in the overall subsidy of Rs1.6 billion per month for a supply of 205 mmcfd.
If oil price comes down at $55/barrel, the subsidy cost comes at Rs431 million and taking unnecessary T&D losses (charged at Rs432mn) out, there is no subsidy required for providing gas at competitive rate of $6.5/MMBTU. If the oil prices come down further, the government would start making money from supplying gas at promised rates.
The reason for narrating the complex calculations is to assert that, if the government hedges the oil prices around $50/barrel, there will be no subsidy need to be allocated for RLNG supply. Yes, there is a hedging cost and it depends upon the interest rates and volatility of prices. The cost of call option would be around 5 percent to take the oil price fixed at Rs52.5/barrel, if the hedge is secured at oil price of $50/barrel.
This way, the government may forgo potential gain, if the oil prices tank further, but will surely hedge the upside. And hedging will give a strong signal to exporters to invest in new projects. At this point, the industry is not sure of continuation of subsidy, given the strained fiscal situation, and not everyone will go into expansion