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Gas pricing structure and excess capacities: Presently, the pricing of natural gas in the country is premised on the provision of cross-subsidies: the household sector (also termed as domestic or residential sector) and fertilizer sector (for feedstock) are subsidized heavily, at the cost of commercial and transport sectors (Figure S1.10). According to the International Energy Agency, Pakistan featured in the top 10 countries providing the most subsidies to the natural gas sector in 2019, with the level close to the one observed in the gas-exporting countries. The amount of the subsidy was around US$ 1,750 million in real terms, or US$ 8.1 per person in Pakistan. For reference, the gas subsidies in India and Bangladesh were US$ 873 million (US$ 0.6 per person) and US$ 824 million (US$ 5.1 per person), respectively (Figure S1.11).

Meanwhile, the LNG price is notified by OGRA on a weighted average basis, after taking into account various factors - such as the import volumes, delivered ex-ship (DES) price, importer margins, terminal charges, retainage and T&D loss adjustments, cost of supplies to pipeline companies, and the margins of the distributors (see Annexure-II for details). The end result is that the imported LNG becomes significantly more expensive than the indigenous natural gas, especially for households, fertilizers (for feedstock) and general industries. The share of these sectors in total gas consumption is around 70 percent, which basically implies that the bulk of gas users would resist shifting to LNG at the prevailing prices. The demand will only be generated in these sectors when indigenous natural gas is not available. In the absence of demand from these sectors, it becomes difficult to utilize the terminal capacities of the FSRUs completely. This, in turn, leads to higher terminal charges per unit of gas sold (Figure S1.12), and the price- demand spiral ultimately feeds into even higher LNG prices and further suppression of demand.

Arrear accumulation with the distribution companies: The slab-wise pricing is resulting in substantial accumulation of arrears with the Sui companies. This is because sectors with access to subsidized rates, particularly the lower slabs of the residential sector and the feedstock slab of the fertilizer sector, are consuming substantially more gas than the ones paying above-average rates. With the cross-subsidy mechanism not working as intended, substantial arrears for the two gas distributing companies are being generated, and these are resulting in a rapidly growing circular debt in the gas sector.

The result is visible if we compare the sector- wise gas consumption with the sector-wise revenues of the Sui companies. For example, while the fertilizer feedstock sector consumes 16 percent of natural gas, it contributes just 3 percent to the revenues of the distribution companies. Likewise, the household sector consumes 21 percent of the natural gas, but contributes only 11 percent to the gas companies’ revenues (Figure S1.13).

S1.6 The ongoing onboarding of private sector and capacity expansions

The analysis presented in the previous section reveals that heavy public sector involvement in all the stages of the supply chain – from assessing demand to imports and pricing – is one of the major reasons for the import delays, price distortions and distribution lags in the domestic LNG market. In order to avoid these problems in the future, Pakistan should learn from other LNG-importing countries in the region, and allow as well as incentivize increased involvement of private sector in the LNG supply chain. This would be in line with the experience of both the more mature LNG markets, such as Japan and South Korea, and some emerging ones, like India. Higher private sector involvement in these countries helped accelerate the adoption of the cheaper fuel across the economy, and smoothen supply chain dynamics by streamlining procurement processes and enabling market- based price discovery.

Encouragingly, in Pakistan, the government has recently started allowing private sector importers to utilize the excess capacities of the existing terminals. The willing players can enter the market in the following way:

  • First, they would need a license for sale of natural gas/LNG from OGRA. At present, Trafigura Pakistan, Energas, and Tabeer Energy have been granted licenses.

  • After that, the private sector players can approach the terminals via a Third Party Access (TPA) arrangement, which would allow them to participate in an auction to secure access to the unutilized capacity.

However, the process of auctioning the unused capacities is complex due to a couple of reasons. First, given that demand fluctuations are common and that the forecast system is not up to par, the private players would remain uncertain of having access to terminal capacity commensurate with the amount booked under short- to medium-term orders by the end-users.

Second, as there are no finalized procedures to oversee the auctioning process (the TPA regulations are in draft form and function as a guiding document), the whole procedure involves all the supply chain players getting into a new FSRU-pipeline usage agreement/understanding each time the government authorizes auctioning of the excess capacities. Note that this adds to the already lengthy procurement process of around 60 days of securing spot purchase deliveries.

Given these operational limitations with the existing terminals, and realizing that the expected demand would remain unmet even after the private sector fully utilizes the excess capacity, the government has started expanding the existing terminals. In addition, the construction of three new terminals (one on-shore and two FSRUs) has also received regulatory approvals.

According to OGRA’s estimates, the country needs the terminal send-out capacity to increase by around 150 percent by FY30, to handle the additional demand of 1,998 mmcfd of LNG; the planned capacity expansions are expected to plug this balance.

Specifically, Excelerate Energy and Engro Elengy have signed a Heads of Agreement (HOA), under which Excelerate will exchange its existing FSRU Exquisite with a new-build FSRU. This would increase the send-out capacity by around 150 mmcfd, and the excess capacity would be available to the private sector via TPA arrangements. Meanwhile, the firm is also working to construct a separate on-shore LNG terminal, PakOnshore LNG, with a projected send-out capacity of 1,200 mmcfd. The PLL is also expanding its capacity by around 150 mmcfd to accommodate orders from K-Electric going forward. Furthermore, the two private companies, Energas and Tabeer, have been granted licenses by OGRA to set up their own terminals. The two FSRUs would have a combined send-out capacity of 1,550 mmcfd. All these expansions are expected to increase the country’s total send-out capacity by 2,900 mmcfd within the next three to four years.

The eventual increase in capacities, especially onshore, means that terminal operators would also be able to store the imported LNG. Storage of gas is vital to: (i) balance the sectoral demand fluctuations due to seasonality; (ii) ensure that the country has supplies available in case of a major disruption in the international supply chain or a sudden increase in regional/global gas prices; and (iii) take advantage of lower prices to lock in supplies for future use.

However, given that LNG storage is costly, there would be a need to make more accurate demand forecasts and improve communication and coordination between the government authorities, importers and terminal operators, to ensure timely deliveries of the required amounts of LNG. Furthermore, terminal send-out capacity of expanded and new terminals would need to be backed up by a commensurate increase in the distribution pipeline network to ensure their business viability.

In particular, the limited pipeline capacity means that there is a lot of uncertainty in terms of their ability to meet the committed future demand. Because of this, planned expansions in terminal capacities would not become operational unless there is sufficient capacity available in the pipeline network (and vice versa).

At present, while the two Sui gas distribution companies have been investing to enhance the pipeline network keeping in view the future demand, the existing pipeline network is still insufficient to cater to the additional demand. In particular, these companies can transport around 1,800 mmcfd of natural gas across the country, with a great amount of monthly volatility during the year. During FY20, for example, around 798 mmcfd of LNG was sold on average via the pipeline network, with the amount reaching as high as 1,270 mmcfd during July and as low as 502 mmcfd during February.

Even in periods with low distribution, it becomes challenging for the Sui companies to accommodate the demand from users/importers with whom they have not signed any Gas Transportation Agreement (GTA). This is because, under the OGRA Third Party Access Rules 2018, any unutilized or excess pipeline capacity is offered to private parties on a three-month forward and first-come-first-serve basis, after approval from all the relevant stakeholders. In this regard, uncertainties in the demand from the private sector and the possibility of any unplanned surge in send-out from the public sector, may discourage both the Sui companies and the private sector from booking the capacity usage three months in advance.

To this end, substantial investments are required to: (i) increase the distribution capacity to supply more gas to users already connected to the gas pipeline network, while expanding the pipeline network to reach off- grid users; and (ii) in the interim period, utilize alternative ways to supply excess LNG to the end-users.

With regards to the first option, the Pakistan- Russia joint project on the Pakistan Stream Gas Pipeline is under consideration. The 1,100 km pipeline would have the capacity to transport around 1,600 mmcfd of LNG. For the second option, two private sector companies - LNG Easy Pakistan and Daewoo Gas - have recently been granted provisional licences by Ogra to establish virtual pipelines to distribute LNG via cryogenic bowsers. LNG Easy Pakistan is planning to use berth at the Karachi Port Terminal (KPT), and Daewoo Gas at the Gwadar Port, for an “integrated LNG project structure,” as per the LNG Policy 2011 to import, transport, market and distribute LNG to mainly off-grid customers at the start. During the short-term, such a process would help bridge the demand-supply mismatch, as virtual pipelines offer the opportunity to import LNG without the need of an LNG terminal; the berthing vessels can offload at the bowsers/tankers present at the berthing/loading ports. The downside is that it is relatively expensive to distribute LNG via virtual pipelines.

In the medium term, the virtual pipeline system can be made part of an extended network serving the transport sector. For example, in India, a network of LNG fueling stations are being installed along the 5,846 km golden quadrilateral highway network, to help enable the heavy vehicles’ switch from diesel to the cheaper fuel. Along similar lines, in Pakistan, the Economic Coordination Committee (ECC) recently allowed OGRA to issue CNG licenses to LNG-based fueling stations with the provision that the stations would neither receive nor later claim an indigenous natural gas supply connection.

(To be continued)

(Excerpts from “The State of Pakistan’s Economy: Second Quarterly Report of the Board of Directors of State Bank of Pakistan”)

Copyright Business Recorder, 2021

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