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BR Research

Refineries: Upgrade or die

Refineries were in a do or die situation ; now (due to COVID) they are in need of ventilator. Since ventilators (go
Published May 5, 2020

Refineries were in a do or die situation; now (due to COVID) they are in need of ventilator. Since ventilators (government fiscal support) are scarce, they should be provided to those industries who have better potential to recover. Not to those who were already (prior to COVID) in need of oxygen support to breathe.

Refineries in Pakistan are working on age-old technology of hydro skimming. They produce environmentally substandard product (Euro2). Plus, fuel oil (furnace oil) has to be produced as a byproduct. Globally, refineries are upgraded to deep conversion. The white product is of Euro 4/5 (better quality fuel), and residual fuel oil can be refined to other products. Refineries in Pakistan were slow to react to the global realities. There is deemed duty charged for long; for producing cleaner fuel, but the production has not been optimized.

The government is thinking of having only Euro-4 fuel by Dec 2020. But not all refineries could upgrade till that time. Government was on negotiation table to have firm commitment by all refineries to upgrade. If they do, government is thinking to support these (by uplifting Euro 2 and helping in selling FO) till the time they upgrade. Else, they have to compete in open market. They won’t be able to sell Euro2 in Pakistan and they won’t be getting other support for maintaining gross refinery margins (GRMs).

Upgradation is also important for getting away with unwanted FO. Globally, it is decided to cut FO use by having IMO 2020. Pakistan’s use of FO is declining due to better fuel power plants coming online. The problem was uplifting of FO. This was a seasonal problem in the last few years. Now, this would be a year-long problem. To do away with this, refineries have to upgrade.

That was the story prior to COVID. The lockdown in Pakistan and nosediving prices of crude and oil products has resulted in huge inventory losses for refineries. They have inventories at very high prices and now have to sell at steep discount. According to refineries’ own calculations, inventory losses were Rs16.2 billion in March and expected losses are at Rs14.2 billion in April. This is half of total equity of refineries (barring PARCO). They are at the verge of being wiped out.

The refineries went to government for a bailout package once again. The national strategic asset clause was once again invoked.  But they got cold shoulder from the government.

World over, governments are supporting industries adversely affected by the COVID. The idea is to not let the economies go in deep recession due to wide array of bankruptcies. Pakistan is doing the same. But it should be for the better future and in larger interest of economy. The government has not come up with any direct cash injection to any business or industries. Cash is only for poor and vulnerable families.

Refineries should forget about any bailout package. Any other form of fiscal support should be hinged upon their upgradation plan. What’s the point of deploying resources to companies who will fail anyways? If that is to happen tomorrow, let them die today. However, for those, who agree to support by signing contracts, government should think about a formula.

Since the government has allowed import of crude, refineries are becoming operational (at better capacity) again; but they need some cash flow support. The GRMs are becoming negative and inventory losses are huge. They are proposing to withhold petroleum levy (PL) for the time being. PL is charged by federal government on petroleum sales. It has increased to Rs30/liter for diesel and Rs23.8/liter for petrol in April.

Economists are arguing that this PL (not be shared with provinces) should be used to support poor and vulnerable families, micro and SME businesses. Plus, this can help reduce fiscal deficit. Someone has to pay back what we are borrowing today. I its tax paper money and it should be used judicially.

Refineries are asking to hold PL till the time they replenish expensive inventories. Once the oil prices change direction, they may start having inventory gains. That is the time they are committing to pay back. Some sort of such formula can be adopted. But on the condition that refineries upgrade. Government should support only those who commit to upgrade in writing.

Consequences for those who opt not to upgrade could be detrimental. Government will go to Euro 4 for all imports by Dec 2020. Since no refinery is compliant, they will go out of business, in case of business as usual. Government will do away with the deemed duty of 7.5 percent and make the prices based on import parity. Government will eliminate 5 percent duty on crude to make refineries have same cost basis – by effectively getting sea freight.

The idea is to completely deregulate once the upgradation is done. The refineries will compete with open imports. The ones who do not agree to upgrade will eventually shut down or have to export their Euro 2 product to other locations that will accept it.

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