Lowering petroleum prices due to abnormal (short term) fall in international prices is not a wise idea. In May20, the prices fell by 15-25 percent for diesel and petrol. That was to partially pass on the impact of fall in international prices to consumers. Not any similar oil importing economy did the same. They kept the taxes high and attempted to save their industries in oil value chain. In Pakistan, consumer's short-term gain was preferred. Eventually consumer has to bear inflation and currency depreciation due to higher twin deficit.
For June, the situation is complicated. Oil and product prices are highly volatile due to an exceptional demand shock and storage problems. The price mechanism in Pakistan is based on PSO's import parity prices in the previous month. In usual days, such practice does not create a systematic problem; but it's happening now.
Recently, international petrol (RON 92) prices came at discount to crude oil. This is peculiar and counterproductive. Petrol is a refined product and usually priced at premium to crude. Since petrol storage capacity is limited (relative to crude), the price fell more.
For example, in April, petrol price averaged at $13.98 per barrel as compared to Arab light at $18.92 per barrel. This trend is normalizing in May with petrol at a premium to crude. Let's bring Pakistan context in it. PSO imports in April got deferred and shipment reached in May. The price was of April but shipped in May. June prices proposed by OGRA are on May shipment (April prices); but international prices have moved north. If OGRA's recommendations are applied, the refineries may not produce (at steep negative margins) and OMCs may not import to avoid inventory losses. This may result in acute petrol shortage in the country.
There are already signs of shortage at petrol pumps. With fall in prices and demand in the past few months, petrol pumps and OMCs had inventory losses. Hence, they started minimizing inventory. But with lift in lockdown and Eid related demand, petrol pumps ran short of fuel. It is a learning experience for them as well. The challenge is to keep optimal inventory.
The ex-refinery price computed by OGRA for June is Rs 20.7 per liter based on April international prices. In May, the petrol (92 RON) international prices are up by 60-70 percent from April levels. No one will work on such negative margins. Refineries may shut and OMCs may not import. The prices would be lower; but supply may be short.
The usual simple formula does not apply here. Innovation is required. A simple long term solution is to deregulate the sector. For now, ex-refinery prices have to be kept high for the industry to be afloat. Else, refineries will be shut and that would have an impact on oil and gas production. The dent is already visible and it will only magnify if business as usual continues.
Some say that when prices move up, these refineries and OMCs make huge inventory gains. They don't share gains with consumers or government. That is a valid concern. The question is why is there a fixation with monthly rates when prices move daily in international market. It's best to revise prices after every two weeks.
The other element is to fix the margins of refineries and OMCs based on the averages in the last year or two. There should be uninform pricing based on cost pooling. Stop making PSO a benchmark for the time being and work on spreads based on actual imports.
That is one leg of the problem. The other is that consumption is being encouraged at low prices. It is a myth that petrol consumption is price inelastic. The historic graph clearly shows that there is uplift in demand in 2015 after steep fall in consumer petrol prices. The structural shift in demand resulted in higher petroleum imports and has some contribution to the 2018-19 balance of payment crisis.
Then there is an opportunity tax loss. Higher taxes in days of lower prices can tame fiscal deficit in bad days and can lower the debt pile up and subsequently reduce the debt servicing pressure. Plus, higher taxes in days of lower international prices can reduce consumer price volatility. In turn, when oil prices are high, the government does not need to increase prices. The inflationary impact can be diluted.
With oil prices moving up, in July, the government would have to increase consumer prices. At that time, transporters and other may try to increase prices. Taxation would be prime consideration in upcoming reviews. The fund will push for increase in petroleum and electricity prices. A good bargain would be to make petrol/diesel prices higher to compensate for keeping electricity prices unchanged. Not to mention that Pakistan petrol/diesel prices are lower than peers, while electricity prices are higher. It is time to think about doing away from this peculiarity.