Rethinking natural gas allocation and pricing: Challenges and path to sustainable solutions

The allocation and pricing of natural gas have been contentious issues in Pakistan, with the government historically granting top priority to domestic consumers, often at the expense of other economically vital sectors such as industry, power, and commercial consumers.

This priority principle, while aiming to provide affordable energy to households, has led to a cross-subsidy mechanism where industrial consumers subsidize the domestic consumers.

In addition, the lack of a comprehensive and equitable pricing mechanism has further exacerbated the challenges faced by the gas sector in Pakistan. In these lines, we will delve into these issues, identify the constraints, and propose a permanent solution that balances the needs of all consumers and promotes sustainability in the gas sector.

The problematic priority principle

The priority given to domestic consumers has resulted in the preferential allocation of natural gas resources to households, often leaving the industrial, power, and commercial sectors grappling with insufficient supply. While ensuring energy security for households is essential, the overemphasis on domestic consumers has hindered the growth of other critical sectors.

The industrial sector, in particular, plays a significant role in boosting the economy, generating employment, and contributing to export revenues. Neglecting its energy needs undermines its potential and negatively impacts the nation’s economic growth.

Cross-subsidy mechanism

The cross-subsidy mechanism, where industrial consumers subsidize domestic consumers, creates an imbalance in the energy market. This practice leads to higher energy costs for industries, discouraging investment and hindering their competitiveness in the global market. A fair and transparent pricing mechanism is essential to ensure that each sector pays the actual cost of energy consumption, encouraging efficiency and sustainable resource management.

Challenges in equitable pricing

The absence of a well-defined Weighted Average Cost of Gas (WACOG) system has been a significant challenge in determining equitable pricing of gas for different provinces and consumers. The lack of a clear pricing formula has often led to disputes between provinces and uneven distribution of gas resources. Moreover, the absence of transparent pricing mechanisms hampers private investment in the sector, as investors seek clarity and predictability in returns.

The issue of gas price determination has emerged as a longstanding problem, contributing to significant financial challenges in the sector.

The regulatory framework, represented by the Oil and Gas Regulatory Authority (Ogra), has struggled with its enforcement capabilities, while successive governments have been reluctant to implement price determinations due to potential political repercussions. This reluctance has led to revenue shortfalls, a strained supply chain, and the accumulation of a substantial circular debt, posing serious economic risks for the country.

Ogra was established to regulate and oversee the oil and gas sector, including the pricing of petroleum products and natural gas. Despite its mandate, OGRA’s effectiveness has been hampered by various factors, including limited resources, capacity constraints, and political pressures.

These factors have compromised its ability to independently determine and enforce appropriate gas prices based on market dynamics, cost structures, and international benchmarks.

Gas price determination in Pakistan is not solely an economic decision but also carries significant political implications.

Gas is a crucial input for various industries and households, and any increase in its price can lead to public outcry, protests, and backlash against the government. This political sensitivity often leads governments to avoid implementing the price determinations recommended by Ogra, fearing electoral repercussions. Consequently, gas prices have remained artificially suppressed, resulting in revenue shortfalls and financial challenges for the gas sector.

The consequences of not implementing OGRA’s price determinations have been severe for the gas sector’s revenue generation and supply chain. The two main gas exploration and production companies in Pakistan, the Oil and Gas Development Company Limited (OGDCL) and Pakistan Petroleum Limited (PPL), rely on revenue from gas sales to sustain their operations.

However, the inability of the gas distribution companies to charge appropriate prices has led to revenue shortfalls, hindering their ability to pay these exploration and production companies. This disruption in the revenue cycle has created a cascading effect throughout the gas supply chain.

The accumulation of unpaid dues and revenue shortfalls has given rise to a significant circular debt problem in the gas sector. The gas distribution companies, commonly referred to as the Sui companies, owe substantial amounts to exploration and production companies.

This circular debt, in turn, impedes the ability of these exploration and production companies to invest in new projects, maintain infrastructure, and sustain production levels. As a result, the overall energy sector’s health is compromised, leading to potential energy shortages and disruptions in the future.

The unchecked growth of circular debt in the gas sector poses considerable economic risks for Pakistan. The country’s energy security, industrial productivity, and economic growth are all at stake due to the inefficient functioning of the gas sector.

Furthermore, failure to address the circular debt problem and implement necessary reforms could result in Pakistan defaulting on its financial obligations, including those to international institutions such as the International Monetary Fund (IMF). Such a default would have severe consequences for the country’s credit rating, access to international markets, and overall economic stability.

The issue of gas price determination in Pakistan is emblematic of the broader challenges the country faces in balancing economic necessities with political considerations.

The regulatory weakness of OGRA, combined with successive governments’ reluctance to implement recommended price determinations, has led to revenue shortfalls, circular debt, and risks to the nation’s energy security and economic stability.

Addressing this issue requires a concerted effort from policymakers to prioritize economic rationality over short-term political gains, ensuring the sustainability of Pakistan’s energy sector and its overall economic well-being.

To address the constraints and challenges faced by the gas sector in Pakistan, a comprehensive and sustainable solution is required. Here are some key steps to consider:

1. Revising the priority principle:

The government should revisit the priority principle and adopt a more balanced approach to natural gas allocation. While safeguarding the energy needs of domestic consumers, equal consideration must be given to the requirements of the industrial, power, and commercial sectors. A consultative approach involving stakeholders from all sectors will ensure the development of a holistic allocation strategy.

2. Implementing an equitable pricing mechanism:

After the enactment of WACOG Law in March 2022, a transparent WACOG-based pricing system has become imperative. This mechanism should consider the cost of exploration, production, transportation, and distribution to calculate fair prices for natural gas including the imported LNG.

Equitable pricing will not only enable cost recovery for producers but also encourage efficient consumption patterns across all sectors. The government must approve and pass on the bi-annual gas price determination by OGRA without any delay.

On July 1, 2023 the OGRA gave its recommendations for gas pricing for the two Sui companies which have not been approved by the government as required under the law. The regulator has recommended a price of Rs 1239 per MMBTU for Sui North and Rs1351 per MMBTU for Sui South for the remaining six months of the year.

Since the government has not approved this price hike, it will inevitably result into revenue loss for the Sui companies which will ultimately be parked in the books of exploration and production companies as receivables.

3. Promoting energy efficiency:

The government should incentivize energy-efficient practices in all sectors. This can be achieved through tax benefits, subsidies on energy-efficient technologies, and awareness campaigns promoting responsible energy consumption. Encouraging energy-saving initiatives will ease the burden on the gas sector and contribute to sustainable development.

4. Encouraging investment in exploration and production:

To augment natural gas supplies, the government should incentivize private investment in exploration and production activities. Offering competitive terms and stable regulatory frameworks will attract investors, leading to increased gas reserves and production capacity.

The government must review such decisions as illegal imposition of windfall levy on oil on those E&P companies who opted to operate under the 2012 policy incentives for any new discoveries made in the blocks allocated to them under 1997 policy. If such unilateral decisions are not reversed, the few international companies which are still operating in the country will leave sooner than we can imagine.

5. Strengthening gas infrastructure:

Investments in gas infrastructure, such as pipelines and storage facilities, are vital to ensure efficient transportation and distribution of natural gas.

Upgrading and expanding the gas network will enhance supply reliability and distribution efficiency. This will require a strong political support as all political governments prefer new connections than refurbishing the existing infrastructure as the former results into everlasting political mileage but causes severe damage to the already crumbling pipeline network of the Sui companies.

The gas sector in Pakistan faces significant challenges due to an imbalanced priority principle and a lack of equitable pricing mechanisms. To achieve sustainable growth and energy security, a holistic approach that considers the needs of all consumers and encourages responsible consumption and investment is essential.

By revising the priority principle, implementing a transparent pricing mechanism, promoting energy efficiency, and strengthening gas infrastructure, Pakistan can pave the way for a more resilient and prosperous gas sector. This, in turn, will contribute to the overall economic development and well-being of the nation.

Copyright Business Recorder, 2023