There is no respite to global economic slump and falling commodity prices are evidence. Europeans are finding it hard to get out of recession. The Chinese slowdown too is signaling recession graduating into depression. The only hope for the world that there is economic pick up in the biggest economy, the US.
Sluggish demand is leading to political tussle amongst players to retain the market share. A classic example is OPECs decision not to cut oil supply. Saudi Arabias extraction cost is the lowest in the world and with crude coming down to $65 per barrel it is not only enough for exploration business to sustain but the country can also run its fiscal surplus without hampering its huge subsidies.
The problem is for Russia as it will hit hard on an economy which is already struggling with sanctions from the West. The theory goes that it is an act to pressurize Russia over the Ukraine issue. The counter strategy could be to disrupt supplies from Ukraine, this or even further escalation of political rift there can further change direction of oil prices.
Another theory goes that KSA and other gulf countries don want to lose their share to shale gas from the US. And any price below $65-70 per barrel of crude will dampen the prospects of technology intensive production of shale and tight gas. It will be interesting to see USs strategy to counter it.
Enough of theories, chances of oil prices to go further south and possibilities of its medium term equilibrium at much lower than previous years average price of around $100 per barrel are high. More economies may slow down by this phenomenon and that can have its adverse impact on other commodity prices as well.
The purpose of portraying the doomed scenario is to explain that chances of falling oil prices adversely affecting Pakistan are higher than the overly positive sentiments. Yes, lower oil price has its magic on improving conditions of an oil importing country, especially where energy woes are paramount.
Low oil price is a big relief for large scale producers having captive power plants on furnace oil. They are right now producing power which is cheaper than the grid. With limited availability of gas, captive power plants can run for six hours a day on gas by producing electricity at Rs7-8 per unit. For rest of the day FO based production is costing them Rs12-13 per unit (it may come down further) against Rs14-18 from the gird.
With this divine intervention, demand from the system may reduce by 300-500MW (assuming 25 big companies having CPP of 15-25MW each) and that can allow some respite to SMEs, commercial and domestic users.
However, if NEPRA passes the fuel adjustment to the consumers, the unit price may also fall. There are high chances consumers will benefit from downward adjustment in fuel price component. The IMF may not like that, but political realities will likely stand out. Fuel price adjustment comes with a lag of three to four months; the corporate can meanwhile make hay while the sun shines, and come back to the grid once tariffs go down.
The next question is whether low oil prices will ease circular debt? Well, if against odds government does not pass fuel adjustment charge, it will lower the losses by having higher revenues net of cost. But given no change in theft (both in billing and recovery), the reduction is circular debt will be much less. Nonetheless, it will be, at least, proportional to fall in oil prices.
An important policy decision is to how to proceed with intended import of LNG, especially the contract tenure. Locking long term contracts on LNG import at exuberant rates of $18 per mmmbtu would be disastrous, as furnace oil would be a cheaper option in new reality of hydrocarbons prices. There should be a mechanism of pegging imported gas prices with crude.
There is a proposal to import 300-500 MMCFD of LNG in the long run dedicated for CNG use. The viability of LNG for CNG users is changing as well. With CNG costing an equivalent of Rs48 per liter and with petrol coming down to R85 per liter in December, the parity is converging.
There will be a case of marginal CNG user moving towards petrol and that may compel CNG players to halt the decision of direct import of LNG. These are tough times for CNG station owners, but its better for the consumers at large as more gas will be available for more productive use.
That was the story of microeconomic factors; lets delve on its impact on macroeconomic dynamics. How would it change the current account balance? What would be its toll on the public finance? How much would it ease inflation? Could it be a cause of picking growth momentum?
The trade balance has worsened as the fall of commodity prices is more visible on the value of exports than the benefit on imports. One reason is that cotton prices have fallen with depressed demand for yarn and cloth from China. While high value added exports of textile items are growing in volume but that is primarily attributed to attaining GSP Plus status for EU countries. Rice prices are down and it may adversely affect exports in next season.
On imports, the first four month bill has failed to show any impact of lower oil prices but from November onwards it will be visible. Keeping demand constant, 20 percent fall in oil prices can lower the oil import bill by $250-300 million per month. However, oil demand is elastic and there will be more demand of petroleum products in months to come.
Another dent on the current account in medium term can be through fall in growth from remittances as the lions share of incremental growth is sourced through GCC countries
At this juncture, consumers are benefiting from low petroleum prices which will fall further in December. This will show its impact on inflation numbers of November and December. But later half of the fiscal year its impact may not be as good. Nonetheless, full year inflation will be around 6-7 percent which is lower than governments target.
Indirect subsidies to agriculture sector can slash the potential of fall in inflation. The sector had to face two shocks this year - floods and falling commodity prices. The government had to come to rescue cotton growers by directing TCP to buy one million bales of cotton - a rare event. Wheat support price is set at Rs1300 per bag for this year which is at 20-30 percent premium to international prices. These indirect subsidies have no immediate impact on fiscal balance but economy at large may pay it by higher inflation.
Last but not the least; its not all hunky dory for the fiscal house. Around 60 percent of FBR revenues are indirect taxes and 30 percent of indirect taxes are coming from oil, gas and petroleum products. Simple math reveals that an annual average 20 percent fall in oil prices can make FY15 target of Rs2810 billion short by Rs100 billion. Its not easy for Dar and company to cope with the shock when Rs145 billion of GIDC is already elusive. This will subsequently axe development expenditure and hence the prospects of growth in FY15 can wait.
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