report on corporate finance (1)

8/7/2019 report on corporate finance (1)

1/18


2/18

Allama Iqbal Open University Islamabad(Department of Business Administration)

ACKNOWLEDGEMENT

All acclamation to Allah who has empowered and enabled

me to accomplish the task

Successfully first of all I would like to thank our Allah

Almighty who really helps me in every problem during the

project. I would like to express my sincere and humble

gratitude to Almighty whos Blessings, help and guidance

has been a real source of all my achievements in my life.

I would like to admit that I completed this project due to

parents who pray for my success.

I also wish to express my appreciation to my supervisor

Mr. Waseem who helps me a lot and introduce me to new

dimension of knowledge.

2


3/18


DEDICATION

My project is dedicated to my beloved Parents,teachers,

brothers, sister and all of my well wishers.

3


4/18


TABLE OF CONTENTS

INTRODUCTION

Definition

Classification

TREND ANALYSIS

International Oil Prices

Domestic Prices

IMPACT ON ECONOMY

Impact on Exports and Imports

Impact on Inflation

Impact on Electricity Price

AN ANALYSIS OF THE IMPACT OF CRUDE OIL PRICEINCREASE

FINDINGS

PROBLEMS

ASSUMPTIONS

RECOMMENDATIONS

CONCLUSION

4


5/18


INTRODUCTION

The high degree of dependence on oil producing countries and any

irregularities in prices and supplies has a pervasive effect for aneconomy that imports crude oil to cater to its often fragile industry.Following the sharp surge in oil prices since 2003, developing countriesthat rely heavily on oil imports, are now faced with an increased threatto macroeconomic instabilities, with Pakistan as no exception.

Definition:-

Petroleum (L. petroleum, from Greek: petra (rock) + Latin: oleum (oil)or crude oil is a naturally occurring, flammable liquid consisting of a

complex mixture ofhydrocarbons of various molecular weights andother liquid organic compounds, that are found in geologic formationsbeneath the Earth's surface. Petroleum is recovered mostly through oildrilling.

Mixture of naturally occurring hydrocarbons that is refinedinto diesel, gasoline, heating oil, jet fuel, kerosene, andliterally thousands of other products called petrochemicals.Crude oils are namedaccording to their contents and origins,and classified according to their perunit weight(specificgravity). Heavier crudesyield more heat upon burning, but

have lowerAPI gravity and market price incomparison to light (or sweet) crudes.

Classification:-

The petroleum industry generally classifies crude oil by the geographiclocation it is produced in (e.g. West Texas Intermediate, Brent, orOman), its API gravity (an oil industry measure of density), and itssulfur content. Crude oil may be considered light if it has low densityorheavy if it has high density; and it may be referred to as sweet if itcontains relatively little sulfur or sour if it contains substantial amounts

of sulfur.

5
http://en.wikipedia.org/wiki/Latinhttp://en.wikipedia.org/wiki/Greek_languagehttp://en.wikipedia.org/wiki/Latin_languagehttp://en.wikipedia.org/wiki/Flammabilityhttp://en.wikipedia.org/wiki/Hydrocarbonhttp://en.wikipedia.org/wiki/Organic_compoundhttp://en.wikipedia.org/wiki/Formation_(stratigraphy)http://en.wikipedia.org/wiki/Earthhttp://en.wikipedia.org/wiki/Oil_drillinghttp://en.wikipedia.org/wiki/Oil_drillinghttp://www.businessdictionary.com/definition/hydrocarbon.htmlhttp://www.businessdictionary.com/definition/gasoline.htmlhttp://www.businessdictionary.com/definition/fuel.htmlhttp://www.businessdictionary.com/definition/product.htmlhttp://www.businessdictionary.com/definition/petrochemical.htmlhttp://www.businessdictionary.com/definition/oil.htmlhttp://www.investorwords.com/10381/named.htmlhttp://www.investorwords.com/8751/according_to.htmlhttp://www.businessdictionary.com/definition/contents.htmlhttp://www.businessdictionary.com/definition/classified.htmlhttp://www.investorwords.com/5714/per.htmlhttp://www.businessdictionary.com/definition/unit-weight.htmlhttp://www.businessdictionary.com/definition/specific-gravity.htmlhttp://www.businessdictionary.com/definition/specific-gravity.htmlhttp://www.investorwords.com/7096/crude.htmlhttp://www.businessdictionary.com/definition/yield.htmlhttp://www.investorwords.com/10230/lower.htmlhttp://www.businessdictionary.com/definition/API-gravity.htmlhttp://www.businessdictionary.com/definition/market-price.htmlhttp://www.investorwords.com/994/comparison.htmlhttp://www.investorwords.com/10193/light.htmlhttp://en.wikipedia.org/wiki/Petroleum_industryhttp://en.wikipedia.org/wiki/West_Texas_Intermediatehttp://en.wikipedia.org/wiki/Brent_oilfieldhttp://en.wikipedia.org/wiki/Omanhttp://en.wikipedia.org/wiki/API_gravityhttp://en.wikipedia.org/wiki/Light_crude_oilhttp://en.wikipedia.org/wiki/Heavy_crude_oilhttp://en.wikipedia.org/wiki/Sweet_crude_oilhttp://en.wikipedia.org/wiki/Sour_crude_oilhttp://en.wikipedia.org/wiki/Greek_languagehttp://en.wikipedia.org/wiki/Latin_languagehttp://en.wikipedia.org/wiki/Flammabilityhttp://en.wikipedia.org/wiki/Hydrocarbonhttp://en.wikipedia.org/wiki/Organic_compoundhttp://en.wikipedia.org/wiki/Formation_(stratigraphy)http://en.wikipedia.org/wiki/Earthhttp://en.wikipedia.org/wiki/Oil_drillinghttp://en.wikipedia.org/wiki/Oil_drillinghttp://www.businessdictionary.com/definition/hydrocarbon.htmlhttp://www.businessdictionary.com/definition/gasoline.htmlhttp://www.businessdictionary.com/definition/fuel.htmlhttp://www.businessdictionary.com/definition/product.htmlhttp://www.businessdictionary.com/definition/petrochemical.htmlhttp://www.businessdictionary.com/definition/oil.htmlhttp://www.investorwords.com/10381/named.htmlhttp://www.investorwords.com/8751/according_to.htmlhttp://www.businessdictionary.com/definition/contents.htmlhttp://www.businessdictionary.com/definition/classified.htmlhttp://www.investorwords.com/5714/per.htmlhttp://www.businessdictionary.com/definition/unit-weight.htmlhttp://www.businessdictionary.com/definition/specific-gravity.htmlhttp://www.businessdictionary.com/definition/specific-gravity.htmlhttp://www.investorwords.com/7096/crude.htmlhttp://www.businessdictionary.com/definition/yield.htmlhttp://www.investorwords.com/10230/lower.htmlhttp://www.businessdictionary.com/definition/API-gravity.htmlhttp://www.businessdictionary.com/definition/market-price.htmlhttp://www.investorwords.com/994/comparison.htmlhttp://www.investorwords.com/10193/light.htmlhttp://en.wikipedia.org/wiki/Petroleum_industryhttp://en.wikipedia.org/wiki/West_Texas_Intermediatehttp://en.wikipedia.org/wiki/Brent_oilfieldhttp://en.wikipedia.org/wiki/Omanhttp://en.wikipedia.org/wiki/API_gravityhttp://en.wikipedia.org/wiki/Light_crude_oilhttp://en.wikipedia.org/wiki/Heavy_crude_oilhttp://en.wikipedia.org/wiki/Sweet_crude_oilhttp://en.wikipedia.org/wiki/Sour_crude_oilhttp://en.wikipedia.org/wiki/Latin


6/18


This brief note provides an overview of international oil price trendswitnessed since 2002. Observations are also made on how domestic

furnace and high speed diesel oil price trends move in consonance withthe international oil prices. The need to focus on furnace oil and highspeed diesel oil prices trends arises from the fact that of the totalproduction by oil refineries of major components of crude oil, dieselconstitutes the highest share of 31% with furnace oil comprising thesecond largest share of 29.4% in Pakistan (200607 estimates).1

This study will then focus on how this increasing trend in internationaland subsequently domestic furnace and high speed diesel oil prices,translate into creating imbalances in the economy by exacerbating thebalance of payment crises, worsening current account deficit, soaring

inflation and impacting the rates of other commodities and inputprices. Consequently, the dire need of exploring alternate andindigenous energy potential perhaps has never been more pressing.

6


7/18


TREND ANALYSIS

International Oil PricesThe global economy has found itself in the midst of an all time oil pricepeak which has also surpassed the peaks experienced during theIranian Revolution in 1970s. This surge is having a compounding effecton the existing macroeconomic challenges for countries whosedomestic economy is consequentially linked with the international oilmarket and other product prices.

World oil average prices during 200304 were over 11% higher thanthe average prices during 200203. End of the 200405 experienced a

sharp upward swing in prices, with an increase of over 41% comparedto the average price/barrel in the preceding year. Newer peaks werereported in price/barrel during 200708 when a 53.4% increase inprices was witnessed, compared to 200607. Overall, there has been a360% increase in price/barrel of oil since the first quarter of 200203 tothe end of 200708, with the first quarter of 200809 opening into evenhigher average prices and etching newer records with prices over$140/barrel on a given day. Figure 1 graphs the recent trends in worldoil prices.

Figure 1

Source: Energy Information Administration, 2008

7


8/18


As evident from the above figure, a rising trend did set in during 200304. After a temporary fall in prices in the second quarter of 200506

there is a sharp upward swing from the third quarter of 200607 andonwards. Analysts suggest an interplay of wideranging factors to havecaused this recent upsurge in the world oil prices.

Strong growth of the world economy after 2003 with China and India asmajor players, undoubtedly have created exceptional demand for oil.2

In face of increased demand, supply rigidities not only continue topersist but are seemingly compounding over time. According to arecent IMF paper on oil movements and its impact on the globaleconomy, even with increasing demandside pressures, the magnitudeof price increase is most likely resulting from oil supply factors, with

OPECs spare capacity diminishing. Additionally, exploitation ofuntapped reserves is significantly falling short of global production ofcrude oil.

According to the IMF, the supply side rigidities, along with geopoliticalscenario have caused oil supply to become markedly binding, thusmaking it extremely vulnerable to even minor disruptions. The fall inUS dollars has also led producers to increase the dollar price in order tomaintain their oil income in terms of stronger currencies like Euro.Lastly, the offlate speculative role of investment banks and key oilmarket players has also been accused of driving up world oil prices.

8


9/18


Domestic Prices

Being an importer of oil, the domestic furnace oil prices in Pakistanfollow the rising trend witnessed in international prices.

Figure 2.1

2 The BP Statistical Review of World Energy June 2008, reports a growth of 7.7% in energy consumption byChina. China also accounted for half of global energy consumption growth during 2007. Indianconsumption grew by 6.8%, the thirdlargest volumetric increment after China and the US. 3 It takes on anaverage 11 years before an oil discovery is ready for production (Elekdag, Selim, Rene Lalonde, DouglasLaxton, Dirk Muir, and Paolo Presenti. "Oil Price Movements and the Global Economy: A ModelBasedAssessment." IMF Staff Papers 55 (2008): 297311).

Figure 2.1 shows that domestic prices of furnace oil rose by 25%during 200405 and over 50% by year end 200506. With a slightdeceleration in prices during 200607 (1.98%) prices during 200708posted a record increase of 57.36%. Holistically, it can be observedthat domestic furnace oil prices have been following very closely the

general price trend observed in the international oil market.

9


10/18


Figure 2.2

A similar analysis of High Speed Diesel Oil (HSD) price trends since200203 reveals that rises in HSDs prices have been relatively lessdriven by international oil prices. Prices rose by only 7.4%, 16.2%, and5.28% during 200304, 200405, and 200607, respectively. Prices rosesharply only during 200506 by 38.15% and during the last quarter of200708 by 22%. The reason why HSD did not closely follow

international price trends was due to the fact that the government hasbeen giving subsidy on diesel to reduce the impact of soaring oil priceson common man as majority of transport fleet in Pakistan consumesdiesel.

10


11/18


IMPACT ON ECONOMY (BALANCE OF PAYMENTS)

The impact of high oil price in international market has reverberated

well into Pakistans economy and has exacerbated the already existingimbalances. The effect of increase in international oil prices remainedrelatively limited until early 200304. This was due to favorable globalconditions, sustainable level of world prices to domestic consumers,and increase in capital inflow especially remittances. Furthermore, thiscan also be attributed to the increase in international oil prices, whichwas gradual.

The recent sharp increase, however, severed through the balance ofpayments in Pakistan, creating a substantial gap between exports andimports (Figure 3).

Figure 3

Impact on Exports and Imports

Exports have increased by only 72% since 200203, whereas importshave increased by 227%. This widening gap has caused the currentaccount to persistently report a deficit, which is growing at alarminglevels. By the end of 200708, total imports stood at around $40 billion;more than twice that of exports. The acceleration seen in imports islargely being driven by the surge in international oil prices and the fact

11


12/18


that Pakistan is heavily dependent on oil imports. This is furthersubstantiated by Figure 4, which shows that the oil

import bill constitutes over 35% of the total import value during thelast quarter of 20078 compared to 25% in the preceding quarter. This

share has increased drastically when compared to the share of 15% inearly 200304. This, along with pressure from increased food priceshas constantly come at a cost of shrinking shares on other items suchas Machinery and Agricultural & Other chemicals.

Figure 4

This certainly has had a negative impact not only on the BOP but alsoposes as a threat to the level of industrialization and technologicalimprovements to the manufacturing sector which then translates intodeteriorating exports. Imports of textile machinery have witnessed anegative growth rate of 17% and 36 % during 200506 and 200607,respectively. Similarly, largescale manufacturing growth too hasexperienced a slump with recording only 4.8% growth during 200708as opposed to 8.6% during 2006 07. 4

Fiscal imbalances have also been created by GoPs continued policy ofproviding subsidy on oil products to protect poor households and thedomestic industry. The burden of subsidies in face of ever increasinginternational prices rise, along with the depreciation of the rupeeagainst the dollar and the debt service burden is adding to thepressure on government budgets and increasing political and socialtensions.

12


13/18


Impact on Inflation

Higher oil prices directly lead to increase in food prices. As a resultthere was a substantial increase in head line inflation. The recent needto import food items like wheat, sugar etc, and depreciation ofPakistani rupee further led to an increase in food prices. Due toincrease in global oil prices and import bill of food group, headlineinflation is constantly going upwards. The impact of inflation wouldhave been even worse, had the government not offered subsidies onoil products and food commodities. Figure 5 shows the inflationexperienced in food prices since 200203 in major groups.

Figure 5

Similar to other developing countries (Ethiopia, Sri Lanka and Ukraine),

Pakistan too faced inflationary impact of rising food and oil priceswhich is likely to be amplified by continuing demand pressures. Otherthan increase in oil prices, the surges in food prices is due towithdrawal or reduction of subsidy on food as existing subsidy becametoo costly for the government.

Soaring oil prices with increased food prices in evidently have anegative impact on growth and drive up the cost of inputs. Both these

13


14/18


factors are posing a great challenge to the macroeconomic situation ofPakistan. Faced with such a situation, the lowincome households findit very difficult to protect themselves against inflation, especially thoseliving in urban areas.

Impact on Electricity Price

Presently, around 30% of the countrys installed generation capacity isbased on furnace oil. It is high time now that the country should reviewits energy mix and start making genuine progress for utilizing alternateenergy sources like wind and solar and for enhancing the share ofhydel, as continued high reliance on furnace oil is becoming more andmore expensive. To date, GoP has been giving subsidy to utilities fornot passing on the impact of high fuel prices to customers. However,since the budget deficit has now gone beyond sustainable limits, thegovernment is now moving away from subsidy and utilities are nowbeing asked to pass on the impact of fuel prices to the customers.Recently, NEPRA has approved an increase in electricity price up to60% for distribution companies, which will be implemented shortly.Since electricity is one of the major components of manufacturing cost,this will not only increase the CPI further but would also hurt thecompetitiveness of our exports.

14


15/18


An Analysis of the Impact of Crude Oil Price Increase

Findings

The recent waves of oil price increases have profound effects onvirtually

all industries. Crude oil prices have risen to a record high, andresulted in price increases for basic commodities and services.

Economic theorists and business analysts figured that thesoaring oil prices which grow by over 50% from 2004 willnegatively influence the world economy. According to Hong KongTrade Development Council, this is because oil prices remain tobe a significant indicator of global economic performance.

As such, oil prices that are determined by supply, demand andspeculation as well as taxes will affect the consumers andcompanies on material and psychosomatic levels.

The petroleum industry classifies crude oil based on itsgeographic location where it is produced and its sulfur content.Crude may be considered light or heavy depending on density; ormay be referred as sweet or sour based on its sulfur substance.

In lieu with this, light and sweet kind of oil is preferred since it is

easier and cheaper to refine. Nonetheless, the crude oil supply ishighly dependent on world oil-exporting nations, collectivelyknown as Organization of the Petroleum Exporting Countries(OPEC).

Prior to the actual price increase, crude oil passes through asupply chain and value proposition strategies that contributes tothe price and its eventual increase or dwindling.

15


16/18


Problems

The study intends to investigate the effects of run-up in crude oil prices

in Pakistan. Specifically, the study is set to answer the followingquestions:

1) How crude oil prices are determined? Why are global oil priceshigh?

2) Why are gas prices across the countries different? What are thefactors that affect gas pricing in different countries?

3) What are the influences of OPEC in determining gas prices inPakistan?

4) How dependent is Pakistan to oil-exporting nations? Howresponsive are Pakistani markets to changes in internationalcrude oil prices?

5) How crude oil prices increase affect the economic performanceof Pakistan? How the price increases affect the consumers,GDP and employment in Pakistan?

Assumptions:

Tax policy plays an important role in determining prices of crudeoil in Pakistan.

GDP, consumerism and employment is highly volatile withrespect to the movement in international crude oil prices.

The demand of crude oil in Pakistani is very high, making the Pakistanipetroleum market as highly-dependent to oil-exporting states.

16


17/18


Recommendations

The research will adopt a positive view wherein the researcherprefers to work with an observable social reality in order to comeup with law-like generalizations similar to those produced by thephysical and natural scientists. Also, the study opt for adeductive approach which will follow the sequence of deducing ahypothesis; expressing the hypothesis in operational terms;testing this operational hypothesis; examining the specificoutcome of the inquiry to either confirm the theory or indicatethe need for its modification; and finally, modifying the theory in

the light of the findings (if necessary).

In addition, the research design for this study will also focus on amulti-method research strategy using semi-structured interviewsand the survey methods of research. A multi-method researchstrategy will be useful for this study because the methods willallowed the researcher to gain more in-depth understanding ofthe phenomenon of the impact of international crude oil priceincreases to country-specific increase on oil prices and the usesof these methods for data collection within one study will ensurethat data are clear, valid and reliable.

This research would employ telephone interviews which allow theresearcher to have a contact to participants with whom it would beimpractical to conduct an interview on a face to face basis becauseof the distance and restraining costs involved and time required toconduct the interview. Data gathered using these instruments willbe collated for analysis. Data analysis will primarily becharacterized by comparative and statistical approach.Afterwards, the researcher will summarize all the information,make a conclusion based on the hypotheses posited andprovided insightful recommendations the topic.

17


18/18


CONCLUSION

Oil prices and its fluctuations continue to pose as a consequentialmacroeconomic concern for both developed and developingcountries.

For oil importing countries like Pakistan the impact of irregularand unexpected price hikes quickly seeps into the domesticeconomy, threatening the already existing macroeconomicimbalances.

Oil price hikes are aggravating the energy shortage in Pakistan

which is now feeding into increased general prices,transportation cost, slowing down agricultural and industrialproductivity and aggravated water shortages for the ruraleconomy.

This is having an enormous financial impact on ourcompetitiveness in the external sector, creating record trade andBOP gaps and depleting our foreign exchange reserves.

In order to move towards attaining fiscal stability andsustainability, the need for tilting away from heavy reliance on oilimports towards alternative energy and fuel options nowbecomes increasingly important.

18

report on corporate finance (1)

Documents