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ARTICLE: The large drop in business activity following the enforcement of strict lockdown and travel restrictions is threatening to push Pakistan into a recession. Poverty and unemployment levels are expected to rise. The government is reprioritizing its expenses by increasing focus on healthcare and ramping up public spending to not only fight the coronavirus pandemic but also provide relief to the poor. But the increase in expenditures will not be accompanied by a commensurate growth in tax collection. This has threatened to push the country's fiscal deficit to alarming levels.

Pakistan's energy industry, particularly the downstream players, were already operating in a tough business environment marked by sluggish economic growth, devaluation of the local currency, slow off-take of furnace oil, and the relentless circular debt crisis. The spread of Covid-19 and the extraordinary weakness and volatility in oil prices witnessed in the last couple of months has made things much worse.

The 50% drop in oil prices in 2020 has wreaked havoc on the energy industry. A bigger concern, however, is the weakness in demand. The lockdown, disruption of flights, strict travel restrictions, and the large drop in business activity has dragged global oil consumption by 17% to 19% from the pre-crisis level, as per various estimates. In Pakistan, the consumption of various refined petroleum products has fallen substantially. The oil marketing companies have witnessed a 36% year-over-year drop in volumetric off-take for April to 1.1 million tons. The restrictions on businesses and individual movements have hurt high-speed diesel (HSD) and motor spirit (MS) demand respectively. The jet fuel demand virtually evaporated after the pandemic ended nearly all domestic and international flight operations.

In many cases, the situation has gotten to a point where the refining margins have slipped into the negative territory. Although easing measures might prop up demand, the energy industry is not going to see a V-shaped recovery as the country's economy shrinks. It could take a while for crude oil and petroleum product consumption to recover completely.

Pakistan's energy sector forms a critical part of the country's economy. The tough business environment can force the energy companies to either slow down or close their facilities but this can have serious ramifications. The refineries, for instance, produce fuel for the motorists, power the supply chain networks of virtually all businesses, cater to the defence sector, and help in maintaining the country's energy security. Pakistan, therefore, can't afford a shutdown of the energy sector. The government needs to step up and take action which will put the energy companies in a better position to handle the downturn.

Pakistan's energy industry has been operating under excessive regulations that hamper the sector's performance. The key aspects of the business are determined by the government, instead of the market. The prices for petroleum products, including diesel and motor gasoline, are set by the government, which goes against the principles of the free market. This breeds inefficiencies and irregularities in the sector and hurts the profitability of the companies.

The government should consider deregulating the petroleum product prices and introduce a new mechanism that gives a greater role to the sector participants, as practiced by several developed countries. Instead of setting petroleum prices and dealer margins, the government should encourage the development of an autonomous energy exchange which will determine the prices of POL products on a real-time basis on the principles of demand and supply, incorporating the landed cost of imported products and other relevant factors. Under this scenario, the 7.5% deemed duty on diesel will also get eliminated. The government, however, will always have its constitutional right to collect taxes and levies from the public in the final pump price, in a transparent manner and across the board.

The inland freight equalization margin, or IFEM, helps in keeping petroleum prices uniform across the country. But this regulation is often exploited by certain quarters at the expense of energy companies and does little besides pushing prices higher for the end consumer. It is suggested the government should abolish this regulation. The removal of IFEM will give birth to several different price levels in all regions of the country. But varying prices will also spur the development of energy infrastructure, such as pipelines, which will create jobs, investment opportunities, and help narrow the price differentials.

The earnings and cash flows of the local refineries and the oil marketing companies are heavily exposed to the movements in commodity prices as well as the PKR-USD exchange rate. These energy companies should be allowed to manage risks associated with adverse movements in foreign currency, crude oil, and petroleum products prices by enacting hedging programs, at least on a provisional basis during the downturn.

The government should also concentrate on removing deficiencies in the market and encourage competition. Currently, the business environment is heavily tilted in favour of a few energy companies, backed by some powerful stakeholders, who have received subsidies in the past, work through lucrative contracts, and receive a guaranteed rate of return in one form or another. This has limited competition in the industry and made some energy companies highly inefficient. These companies now constantly rely on government support, be it in the form of allocation of local crude oil quotas or access to the key oil transportation pipelines, even during periods of economic growth. The policymakers are advised to start rolling back incentives and focus on providing a level playing field to all public and private sector energy companies. This will force inefficient organizations to improve their operations, reduce costs, and increase product quality.

The authorities should also make sure that the energy industry's participants strictly adhere to existing policies, regulations, and rules which provide support to the domestic energy companies and reduce Pakistan's reliance on foreign oil. For instance, the regulators should ensure that the oil marketing companies follow the rules which require them to source petroleum products from the local oil refineries that meet the environmental and quality standards. The OMCs should approach foreign sellers only if the local refineries fail to meet the government-mandated standards or when domestic supplies get exhausted. A system of penalties, which could be applied to either party, should also be introduced to increase compliance with this regulation.

This brings us to an important point. For the smooth roll-out of any deregulatory measures and to eliminate imbalances from the energy market, it is imperative that the government strengthens its oversight umbrella and policy enforcement. This can only be achieved by empowering the regulators, including OGRA and the Competition Commission of Pakistan, with greater vision and oversight of the industry. This will help address the above-mentioned as well as countless other issues which have corroded Pakistan's energy industry and hurt consumers, such as collusion among companies, artificial supply shortages which push prices higher, poor quality of petroleum products, and development of storage facilities, terminals, and other related infrastructure which fail to meet the minimum volume requirements.

The energy industry is going through a challenging period. But the government, by collaborating closely with the industry's participants, can turn this downturn into an opportunity which will enable the energy companies to emerge even stronger from the crisis.

(The views expressed in this article are not necessarily those of the newspaper)

Copyright Business Recorder, 2020