Bold decisions needed to handle oil price shocks

Oil prices were already soaring at the start of the year. The rally was being driven by the jump in demand in the aftermath of recovery from the coronavirus pandemic and tight supplies. The conflict in Ukraine pushed the commodity to above $100 a barrel. Although oil has fallen from recent highs, risks to the upside remain in an uncertain geopolitical environment.

This puts Pakistan – an oil-importing country – in a tough spot. To navigate through this storm, the country’s policymakers might have to make some bold and difficult decisions. The latest rally in oil prices has been fueled in large part by fears surrounding the disruption in oil supplies following Russia’s attack on Ukraine. Crude oil exports from Russia represent 8% of the global supplies and might get crippled by Western sanctions.

Oil traders from the US and Europe, as well as from other countries who want to avoid getting caught up in the Western sanctions, might look to buy crude oil from other sources in a market where oil is already in short supply. The US has banned all imports of Russian oil while the UK expects to gradually phase out its supplies by the end of 2022. Russia’s oil and gas production plays a small part in the energy mix of these two countries, which is why they could afford to take tough measures.

The UK gets just 4% of its gas, 8% of its oil, and 13% of its diesel from Russia while its petrol imports come from other countries. The US imports most of its oil from Canada, Mexico and OPEC members. Russian supplies account for just 3% of the US’s overall oil imports and 1% of its total refinery output. EU states, meanwhile, are reportedly preparing to slap even tougher sanctions on Russia, especially on its oil and gas giants Rosneft, Transneft, and Gazprom Neft. But unlike the US and UK, Europe relies heavily on Russia’s oil and gas production, which is why it has stopped short of imposing a blanket ban on Russian imports.

Europe gets approximately 27% and 40% of its oil and gas supplies, respectively, from Russia. Pakistan’s economy has already been hit hard by the high energy prices, as evident from the trade deficit that climbed 82% year-on-year to $38 billion in the first eight months of current financial year, data from the Pakistan Bureau of Statistics (PBS) shows.

The massive deficit, which has grown for eight months in a row, can be partly attributed to high energy prices. Pakistan spent a record $12.9 billion on buying crude oil and refined products like petrol, LNG and LPG at high prices in the first eight months of FY22 – that’s equivalent to a quarter of the country’s total imports. The deficit could expand further with rising oil prices. Moreover, the budget deficit could also come under additional pressure after the government decided to give relief to the masses by cutting petroleum product prices by Rs10 per litre and electricity tariff by Rs5 per unit.

Petroleum product prices have also been frozen for the next four months. This relief could translate into a subsidy of Rs250 billion to Rs300 billion, as predicted by the finance ministry spokesperson. The problem with subsidising fuel prices, however, is that the relief goes out to everyone – the poor who are struggling to make ends meet as well as the rich who don’t need it. Besides, this subsidy might also end up hurting the Public Sector Development Programme (PSDP) – a critical component of economic growth. Remember, the government has already slashed the PSDP budget for the current fiscal year to Rs700 billion from an initial estimate of Rs900 billion.

The reduction was done to contain the soaring budget deficit which, as per the finance ministry’s estimate, could rise to an all-time high of more than Rs4.3 trillion this fiscal year. But now, to fund the relief package, the PSDP may be curtailed again, which can harm economic growth. Instead of giving blanket subsidies, the government should consider spending money on efforts that can lift domestic energy supplies and strengthen the country’s energy infrastructure. As mentioned earlier, Pakistan has been spending billions on importing petroleum products – like petrol and diesel – which are more expensive than crude oil.

However, these products can be produced at home as well. Domestic refiners are fully capable of meeting most of Pakistan’s fuel demand and have shown willingness to expand capacity. Some are even installing new plants, although the industry has been struggling due to a lack of supportive policies. But by making the business environment lucrative for the oil refining industry and offering incentives that encourage investment, the oil refineries can quickly grow and meet virtually all of the country’s fuel demand. Such concentrated efforts can enhance Pakistan’s capacity to produce petroleum products, which will reduce our dependence on foreign fuels, bring down the import bill, put the country in a better position to handle oil price shocks, and improve energy security.

Furthermore, an increase in investment in the oil refining industry will lead to more employment opportunities and economic growth. Alternatively, the authorities can also spend money on measures that can not only help lift but also diversify Pakistan’s exports. The incentives and subsidies that are primarily utilised by the textile sector, which alone is responsible for 60% of Pakistan’s exports, should be opened up to other industries as well, which are willing to tap into the export market. With the right structure of incentives, even the oil refining industry can start producing excess quantities of petrol and diesel, which can be exported.

Other industries, such as pharmaceuticals, can also contribute greatly with higher exports. If the government aimed to immediately provide relief to the poor amid soaring international oil prices, then perhaps it would have been better if the policymakers had bolstered the Ehsaas programme or other social security projects. Through targeted subsidy, the money would go directly to those most in need, as opposed to the current scenario where those who can afford luxury cars are also getting the aid. Perhaps, this might be a good time for the government to reconsider the relief package and take the bold decision of diverting the funds towards more productive uses.

THE WRITER FOCUSES ON SUBJECTS OF BUSINESS AND ECONOMICS, SPECIALISING IN THE ENERGY SECTOR