Mother of all furnace oil crises

Furnace oil (FO) prices nosedived in the international markets due to IMO-2020. The world view is that FO prices are less likely to recover. If that happens to be the case, it could spell trouble for Pakistan refineries, unless they are bailed out by government. Ironically, refinery stocks are booming at the PSX. This hints that something other than fundamentals are driving stock market.

All refineries in Pakistan are operating on old methodology and have to produce 25 percent FO invariably on each barrel of crude oil refined. With FO prices at almost 50 percent discount to crude oil, the refineries will make huge gross losses. These may shut down one by one. Almost half of the country’s petroleum products are produced by local refineries. The burden will pass on to the imports. The port infrastructure to handle and store petroleum products is chocking at current import levels. No room to handle more. There will be acute shortage of petroleum products in the country at unprecedented levels within months, if not weeks.

Globally, refineries are on average producing 5 percent of FO in the product mix while Pakistan’s refineries are producing 25 percent. The gross refinery margins are around $5-6 per barrel. FO has for long been a loss making produce, but losses used to be compensated by gains on other products. Now with FO prices nosediving – from negative spread of $4.1 on Arab light in FY19 to $28.5 in Nov-19, the refineries would be better off to shut down.

The petroleum crisis is brewing and the magnitude of this sort was not seen before. Government unfortunately would have no choice but to bail refineries out. The port handling capacity is simply not enough to meet any additional petroleum products. There are three piers at Port Qasim for birthing oil cargos. One is already closed, second is damaged and only one is fully operational.  The issue is not arising out of the blue. The writing was very much on the wall. There has been a case of upgrading Pakistan refineries for long, but the rent seeking elements in refineries sought for government support, and they probably will get the rent out of this crisis.

The winter crisis of FO is becoming a norm in Pakistan. This space has been preempting it for past two winters. Crisis came and went without any meaningful development to avert future catastrophe. The world is moving away from FO because of its high Sulphur content. The refineries around the globe have up graded from hydro-skimming to deep conversion. It takes 4-5 years for building new or upgrading existing.

In new technology, there is less or no production of FO. The demand of FO is falling globally, including Pakistan. Pakistan used to consume 9 million tons of FO couple of years back and out of it around 3 million tons was local production (capacity). Now virtually there is zero import of FO, as demand is shifted towards RLNG and coal. In winters due to low power (electricity) demand, for the past two years, there was pressure on domestic FO off-take.

This phenomenon had created crisis in last two winters. The resolution was to create additional storage within existing infrastructure and running FO based plants even when these were not eligible on merit order. The long term solution is to convert refineries to modern technology. The stopgap solution is to export surplus FO by giving subsidy or other facilitation. No progress on it either.

The usual winter crisis is looming again. The storage capacities are exhausting. The bigger problem is unsustainability of refineries operations with fall in FO prices. IMA (International Maritime Organization) will implement a new regulation for a 0.5 percent global Sulphur cap on marine fuels. The demand of FO will be down significantly and that is driving down international prices.

Interestingly, at current prices FO should come higher on merit order of IPPs. FO prices are at a steep discount to RLNG - adjusted for efficiency factor, FO based power production may become cheap. But it is not viable for refineries to produce FO at current prices. Ministry of Petroleum and refinery producers have to sit down immediately to avert the crisis. Refineries are pushing for AGN Kazi formula which was there prior to 2000. Unfortunately, the industry is receding two decades back.