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Gas sector reform: beyond pricing – Opinion

Finally, pricing reform in the gas sector is in sight. The summary has been moved, and prices are likely to increase soon (before the IMF review). The gas circular debt stood at Rs1.5 trillion (exclusive of duplication of power sector debt and late payment surcharges) as of end-June 2023. The proposed price increases are likely to stop the flow of gas circular debt.

It is not easy to increase the gas prices in Pakistan. The caretaker energy minister has repeatedly emphasized in public on the increase (55 times, according to an independent observer’s calculations) ever since he took oath. And now it is happening.

However, it is not an equitable increase across the board. One of the top consumers of domestically produced natural gas is in the fertilizer sector where the proposed increase is at notional rate of 5-14 percent while the increase across all the other sectors (barring households) ranges from 90-136 percent.

Pakistan’s estimated demand from natural gas (excluding LPG) is 4,100-4,200 mmcfd – out of which 3,200 mmcfd is being supplied locally while 900-1,000 mmcfd of LNG is being imported.

The imported gas (which is most expensive) is being used in the most efficient (60 percent+)power plants while the local gas is supplied at much cheaper rates for inefficient use –general industry and captive power are priced at one-third of LNG prices while their efficiency is around 40 percent. In the case of commercial and households, the efficiency is even lower.

These historic low prices for inefficient use have misallocated the precious indigenous energy sources of the country that have contributed to overall low economic productivity and has seeded other macroeconomic illnesses. One fundamental reform is price rationalization for better allocation of resources.

That optimal allocation of resources should be the main motivation behind gas price increase. However, primary consideration is to stop the flow of growth of gas circular debt. The price increase is proposed keeping the same in mind. The gas circular debt has been growing rapidly in the past few years as domestic gas reserves are declining and imported RLNG share is increasing in the fuel mix.

The gas circular debt was Rs 550-600 billion at the start of 2021, and is now at Rs 1,500 billion. The toll of Rs 2,700 billion which the energy minister quotes include some duplication of power sector debt and LPS. Excluding duplication and LPS, gas circular debt is around Rs 1,500 billion and power sector debt is at Rs 2,300 billion (total energy sector circular debt is Rs 3,800 billion). With the recent electricity prices increase the growth of power circular debt has been almost plugged, and now proposed gas price increase will plug the gas sector debt as well.

That was required to be done. But more reforms are warranted. Energy use should be based on efficiency, not on the cost of production. For example, cost of production of Mari gas is amongst the lowest, and that is mainly provided to fertilizer sector at lowest prices (barring protected domestic consumers). And the cost of import is highest for LNG and RLNG is being mainly used for power plants.

Ideally, low-priced gas should be provided to power sector efficient plants and that shall help transferring the load of households (space heating) and captive industrial use (without combined cycle) to power, and potentially lower the overall electricity prices. And if some industries have combined cycle plants, they can be competitive by paying higher gas prices, instead of opting for grid power.

In the case of fertilizer, the equation is a bit more complicated. The subsidy is in the shape of providing gas at cheaper rates to urea producers, and they in turn supply urea at lower than international prices to farmers. However, not all the gas subsidy is being passed on to the farmers which is evident by very high EBITDA margins (average last five year’s margin is at 32 percent for Big 3) for listed fertilizer companies in Pakistan.

The subsidy mechanism needs to be revisited. This model is rare to find elsewhere in the world. Even in India, the subsidy, though routed through fertilizer companies, is based on cost plus approach and is paid to urea manufacturers through concession rates.

One way for Pakistan is to follow the Indian model, and the other is to provide direct subsidy to farmers while providing gas to fertilizers manufacturers at market competitive rates. In India, more than 50 percent of imported RLNG is provided to fertilizer companies while Pakistan is providing cheapest produced local gas.

Urea is essentially conversion of gas to fertilizer – 1 ton of urea requires around 30 MMBTU of natural gas – or 630 kg of gas for 1 ton of urea. Globally, fertilizer prices tend to track natural gas prices. The question should be whether we import urea or LNG and should revisit the subsidy model. Especially, when the urea (cheaply priced gas) is being smuggled.

Such strategic reform is still missing in the gas sector. Here the lobby of urea producers is overpowering the energy ministry. Pakistan needs to question the age-old mythologies being used to support certain industries. There are many other examples (to be discussed subsequently). We should start calling spade a spade.

Copyright Business Recorder, 2023

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