The dilly dally on refinery policy is on-going. In the haste of budget meeting by the new team (both at petroleum and finance), the policy incentives were incorporated in the finance bill without approving the policy itself. This is like putting cart before the horse. The year-long negotiation by the previous petroleum team lost gist in the heat of recent meetings.
Four out of five oil refinery companies in Pakistan will die if they don’t upgrade. One is partly important for strategic reasons, rest of three Karachi based refineries have no future without massive upgradation. (read “Refineries – do or die” published on 12th December 2019). Not much has changed since then.
Principally, the refinery policy should come. The question is how much support should be given to the sector, and what is the opportunity cost of supporting existing refineries and allowing new ones. Then the question is what form of technology should the government support. After weighing the options and (ideally) conducting a study by an international expert, government should table the incentive structure.
Nonetheless, the policy is already tabled. There are three incentives. One is income tax holiday. The other is duty waiver on plant and machinery imports. And the contentious incentive is imposing custom duty on import of refined products (such as petrol and diesel), to be priced in the product. This way, local refineries would have 10 percent margin in kitty. Essentially, consumer will have to pay 10 percent on every liter of petrol consumption to refineries.
There are two questions. One is what is the basis of 10 percent incentive. Why can’t it be 7 percent or 12 percent? And the big question is about the timing of the duty. The policy draft says that the incentive will be applied from 1st January 2022. Ministers are pressing on this to be applicable once production for new (or upgraded) plants kick in. The industry is demanding that government should start charging from consumers from 1st Jan 2022 but give them to refineries once the EPCC is awarded. That means consumers would be charged invariably, but government will only pass on the refineries once the actual upgradation starts.
The government fears that some players may not upgrade after collecting duties. As refineries have been charging from consumers under the name of deemed duty on diesel and some think that they have not upgraded enough. Well, refinery players say that they did spend on upgradation and sustainability of the industry.
Examples from region suggest that without support, the new capacity or expansion may not take place. The situation for refineries in Pakistan is such that status quo cannot be maintained. If refineries do not commit to upgrade, after a year from the new policy, government will stop buying Euro 2/3, and any refineries (barring Parco) will have to export without upgradation. Not many markets (apart) from some African countries to sell. Effectively, these will die.
For government, the question is whether supporting too small or too old refineries is economically beneficial for Pakistan. For refineries to be competitive, certain scale is needed. Combining all Pakistan existing refineries (barring PARCO) effective capacity is almost same as a new refinery. The policy dilemma is why to support PRL for its tiny size or Byco for too old plants. But government cannot pick and choose, it must give right incentive structure where only those who qualify for expansion participate.
The context of setting 10 percent duty is imperative; the duty is to get lower in staged manner and floored at 5 percent. Here the negotiating team is missing and that is causing the confusion. When the negotiations in 2020 started, the refineries were demanding 15 percent duty cover. The premise was low refinery margins in COVID days. It was negotiated at 10 percent, as situation was improving. Now with increasing prices, refinery margins are much better.
The government should work on this lever to eliminate unwanted refineries. It can reduce the duty to 7 percent. Here if a refinery is too small to not recover its capital, let it die. If plants are too old, the cost of expansion could be too high for them to recover at 7 percent, let them die. In this case, older plant of Byco and one plant of Attock refinery which is over 100 years old may not compete.
The example of 7 percent is arbitrary, government should think to work on these lines, and similarly floored number needs to be revisited. However, not giving any duty incentive would mean government is letting all four to die. And the other question is the timing of the incentive. One company CEO has categorically said that their sponsors will not invest without getting upfront duty incentive (payment can be deferred). Here government’s argument is that if the consumers are paying in expansion, they should be equity partners – or government becomes equity partner in these projects.
All these questions are to be deliberated and policy needs to be tweaked. If the government does not support existing refineries and extends the benefit for the new by linking incentive to the date of production, the port and pipelines capacity to handle white oil products needs to be examined. And the national security element should be kept in mind. However, calling a day for local refineries may not be a prudent approach. It is just negotiations that are ongoing, and government should not go easy on anyone seeking rent.