The crack/refining margins of diesel (HSD) over crude oil have become abnormally high in the last few weeks after the Iran-US war broke out. The government’s first reaction was to pass on the impact to consumers by keeping the formula based on average Platts prices intact. That resulted in the HSD price almost doubling to Rs520/litre, even with no petroleum levy.
The beneficiaries were local refineries, as around 70% of HSD is refined locally, which were making windfall gains at the expense of consumers at large. BR Research was among the first to highlight the issue and spoke at length with the petroleum minister, Ali Pervaiz Malik, and refinery industry stakeholders.
Read More: Malik speaks about diesel pricing formula: ‘Voluntary’ deal reached with refineries
They did listen to the reasoning. The government sat down with refinery representatives and finally came up with a formula to cap profits at the last five-year weighted average crack of $6.16/barrel. Based on post-war crack margins, which are very high on HSD while negative on petrol (MS) and FO, they came up with a cap of $41.89/barrel on HSD. To ensure refineries do not make losses, the floor has been set at $11.33/barrel.
Without debating the detailed calculation, the decision is right, and the credit goes to the petroleum minister and refineries for coming up with an amicable solution.
The government should have done this earlier, as such abnormal profits were also made in June 2022, when the then government did not give heed to the issue. Interestingly, the then finance minister is now pushing for revisiting the formula, although he did not act when he was in power.
Anyhow, it is now fixed, and the impact on inflation will be lower. The government has set the new formula for three months. Meanwhile, the debate should be about the future of the age-old five refineries.
The question is whether pricing should be deregulated or the newly devised formula should continue beyond three months. Do we need a refinery policy, or should we continue with the existing framework?
Refineries are long-term projects, and we should think decades ahead before making a policy call.
The energy mix is changing globally. Vehicle electrification is happening fast. Reports suggest that MS/petrol consumption may remain stagnant, if not decline, in the coming decades. However, HSD and jet fuel demand may increase.
Pakistani refineries already produce a high amount of HSD. The problem they face today is what to do with FO. That can be addressed by having a mid-country facility at PARCO to crack FO into other usable products — a proposal coined in 2020 by the then petroleum minister.
We should deliberate on these issues before committing fiscal incentives to existing refineries. We should not overcommit capacity, as we did in the IPPs and LNG sectors. A more important need is to build strategic petroleum reserves, and the ministry should double down on getting this done before the next crisis hits.
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