Oil sector rejects guaranteed return

Calls proposed model misplaced that will require year-round subsidies

ISLAMABAD:

The oil industry has turned down the proposed revision in the existing fuel pricing formula by switching to a guaranteed return model, warning that such a move will effectively force the government to give subsidies across the year.

Former ministers and analysts have reignited debate pertaining to Pakistan's refining sector. Much of this discourse, however, reflects a superficial understanding of refinery economics and risks leading to policy prescriptions that could undermine the fuel supply chain.

At the centre of this debate are calls to revisit the existing pricing framework and introduce a guaranteed return model for refineries. Such proposals ignore both global industry practices and Pakistan's fiscal constraints, industry players say.

The current pricing mechanism, linked to international benchmarks, is neither arbitrary nor experimental. It is a globally implemented and time-tested framework that ensures alignment with international markets.

"Replacing this with a guaranteed return model will effectively mean that the government subsidises fuel prices across the year, an approach that is fiscally unsustainable. It is worth noting that the government itself has moved away from such models, while institutions like the IMF have consistently discouraged open-ended subsidy regimes," an oil industry official remarked.

He added that over the past few years, the listed refineries in Pakistan have collectively incurred losses exceeding Rs100 billion, highlighting the structural challenges faced by the sector. Compared to other industries, refinery returns on investment remain among the lowest, despite the sector's strategic importance.

Industry officials argue that policies governing a capital-intensive sector like refining cannot and should not be recalibrated based on a single month's margin movement. Yet much of the recent commentary appears to do precisely that, extrapolating short-term gains into a case for structural policy change. Refining margins are inherently cyclical and, in many cases, structurally constrained. Periods of relatively stronger margins are rare and typically linked to extraordinary geopolitical events.

"Such conditions may emerge once in a decade, often in conflict-driven environments, and are not indicative of the sector's long-term economics. For most of the time, refineries operate under pressure, with several product streams generating negative returns," they said. A significant proportion of refinery output, including furnace oil, gasoline and bitumen, frequently trades below crude parity. Losses on these streams erode overall margins, even when select products such as high-speed diesel show temporary strength. "Ignoring this product slate reality leads to fundamentally flawed conclusions."

They termed it misleading to assess refinery economics based solely on benchmark crude prices. The landed cost of crude includes premiums, freight, insurance, duties and financing, all of which have risen sharply in the current environment. Freight and war risk charges have increased multiple times, insurance premiums have surged and financing requirements have expanded significantly due to higher cargo values and constrained credit lines. These factors have substantially increased working capital requirements and further compressed margins.

If the objective is to examine "windfall gains," the focus may be misplaced, the industry players stressed. The upstream exploration and production (E&P) sector, which sells indigenous oil and gas at internationally benchmarked prices, is the primary beneficiary in such periods.

A significant part of this sector is government-owned, meaning that higher prices translate directly into increased revenues for the government and higher tax collection for the Federal Board of Revenue. In contrast, refineries operate on thin and often negative margins, with limited ability to capture such upside.

"This raises the fundamental issue of policy consistency. If refineries are required to operate under market-based pricing during periods of weak margins, it is difficult to justify calls for intervention when margins temporarily improve," the oil industry said, adding that selective application of policy principles risks distorting incentives and undermining investor confidence in the capital-constrained sector.

Pakistan's refining sector is a critical link in the domestic energy supply chain. "Policy decisions affecting it must, therefore, be grounded in a clear understanding of cost structures, product dynamics and long-term sector viability, not short-term market movements or incomplete comparisons," it said.

Reactive policy shifts, particularly those that introduce fiscal liabilities, may offer short-term political appeal but carry significant long-term risks. In a sector as complex and strategically vital as refining, consistency and clarity in policy will be essential to ensuring energy security and sustaining investment, the industry said.