term paper pakistan economy
TRANSCRIPT
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Trends in Oil PricesTERM PAPER
Resource Person
Khola Shahid 083805-206
M.Rabee Rehmani 083805-196
Haroon Ahmad 083805-217
Ali Ejaz 083805-170
Miss Afia Mushtaq
Group Members
University of Management and Technology
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Abstract
Oil price shocks have raised serious concerns among the policy makers around the world,
because of its adverse impacts for the net oil importing economies. This paper has analyzed
the impact of rising oil prices along with the changing macro conditions on output using the
IS, monetary policy and augmented Phillips curve for Pakistan. Oil prices and output are
found to be strongly related, and to a great extent this relationship is non-linear, that is, after
a certain level it becomes negative. In addition, lower debt-GDP ratio, lower deficit
spending, lower real effective exchange rate, and the existence of foreign exchange reserves
and capital investment would cause output to rise.
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Table of Contents
1.Introduction......................................................................................................................................... 5
2.Problem Statement.............................................................................................................................. 7
A. Inflation and Oil Price
3.International & Domestic Oil Prices
i. International Oil Price ........................................................................................ 9ii. Domestic Oil Price ............................................................................................ 10
4.Causes of fuel trends
A. Fuel and US pricing ........................................................................................................................ 11
B. Factors affecting the cost for the customer ............................................. ....................... ................ 12
i. Cost of production and delivery of diesel fuel to consumersii. Operating Cost of Retail Station
iii. Federal, State and Local TaxesC. Global market factor affecting retail price of fuel ............................. ....................... ...................... 14
i. Supply and Cost ofCrude Oilii. Worldwide Production Capacity & International Demand of Diesel Fueliii. Imbalances in Supply & Demandiv. Seasonal Variations in Demandv. Geographic Variations
D. Worldwide increase in fuel price ......................... ................................ ...................... ..................... 16
i. Fuel Productionii. Increased Demand for Dieseliii. Stringent Environmental standardiv. Fuel Taxes
E. A closer look at the Rise & Fall in 2008 ........................... .......................... ............................. ......... 17
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5.Impacts of High Oil Prices
i. Oil Dependency ............................. ......................... ................................ .......... 21ii. Macroeconomic effect ..................................................................................... 24iii. GDP growth and oil prices ................................................................................ 25iv. Balance of payment effect................................................................................ 27v. Fiscal Impact .................................................................................................... 29
vi. Impacts on exports and imports ....................................................................... 316. Forecast for the Year Ahead
i. Projected Price Trends ..................................................................................... 31ii. Projected Consumption Trends ........................................................................ 31iii. Projected Supply Trends ........................... ............................. ...................... ..... 32
7. Recommendations ............................................................................................................................ 33
Conclusion............................................................................................................................................. 35
References ............................................................................................................................................ 36
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1. Introduction
The high degree of dependence on oil producing countries and any irregularities in prices and
supplies has a pervasive effect for an economy that imports crude oil to cater to its often fragile
industry. Following the sharp surge in oil prices since 2003, developing countries that rely
heavily on oil imports, are now faced with an increased threat to macroeconomic instabilities,
with Pakistan as no exception.
This brief note provides an overview of international oil price trends witnessed since 2002.
Observations are also made on how domestic furnace and high speed diesel oil price trends move
in consonance with the international oil prices. The need to focus on furnace oil and high speed
diesel oil prices trends arises from the fact that of the total production by oil refineries of major
components of crude oil, diesel constitutes the highest share of 31% with furnace oil comprising
the second largest share of 29.4% in Pakistan (2006-07 estimates).
Chart plots the annual change in the real prices of crude oil for the period 1961 to 2008. The
figure shows that the price of oil jumped sharply twice in the 1970s. In 1973-74, oil prices
increased by an incredible 222% in real terms and 257 % in nominal terms. In this sense, the
present price level is not unique. The increase in oil prices during 2003-08 occurred relatively
gradually, allowing countries more time to adjust. For example, the oil prices in real terms rose
by 13 % in 2003, 27 % in 2004 and 37% in 2005. Then it was decelerated to 16 and 8 % in 2007,
before rising by a dramatic 69% in 2008.
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2. Problem Statement
This study will specifically focus on how this increasing trend in international and subsequently
domestic furnace and high speed diesel oil prices; translate into creating imbalances in the
economy by soaring inflation. It will also focus on how high oil prices exacerbated the balance
of payment crises, impacted the rates of other commodities and input prices and the effected the
exports and imports of the country. Consequently, the dire need of exploring alternate and
indigenous energy potential perhaps has never been more pressing.
A. Oil Prices and InflationHigher oil prices directly lead to increase in food prices. As a result there was a substantial
increase in head line inflation. The recent need to import food items like wheat, sugar etc, and
depreciation of Pakistani rupee further led to an increase in food prices. Due to increase in global
oil prices and import bill of food group, headline inflation is constantly going upwards. The
impact of inflation would have been even worse, had the government not offered subsidies on oil
products and food commodities.
Figure shows the inflation experienced in food prices since 2002-03 in major groups.
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Similar to other developing countries (Ethiopia, Sri Lanka and Ukraine), Pakistan too faced
inflationary impact of rising food and oil prices which is likely to be amplified by continuing
demand pressures. Other than increase in oil prices, the surges in food prices is due to
withdrawal or reduction of subsidy on food as existing subsidy became too costly for the
government.
Soaring oil prices with increased food prices are evidently have a negative impact on growth and
drive up the cost of inputs. Both these factors are posing a great challenge to the macroeconomic
situation of Pakistan. Faced with such a situation, the low-income households find it very
difficult to protect themselves against inflation, especially those living in urban areas.
Another channel via which high oil prices may affect macroeconomic performance is through the
high costs of production thus reducing output. This supply side channel exerts an inflationary
pressure on the economy. In addition, higher oil prices directly raise consumer prices via higher
prices of imported goods and petroleum products in the consumption basket. Another implicit
effect is felt as producers pass some part of higher input (oil) costs to the price of final goods.
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Moreover, consumers who experience a loss in real income may consider seeking wage
increases, which feed back into higher production costs, and then into prices. However, when oil
prices fall, nominal wage and other price rigidities can limit the pass through to lower final
goods prices.
When the rate of inflation is high, governments may be concerned with adding it further and
hence less willing to see a full passing on of oil price increase. High oil prices has also become
an important factor (along with rising house rents and shortage of food items) contributing to
high inflation in Pakistan in the past few years. General Price level (for virtually all goods and
assets) has been increasing (9.3 percent in 2004-05 considerably very high compared to the
previous years). Even in the last two years average inflation was near 8 percent (Table 1).
Despite efforts from SBP through tight monetary policy19 (high interest rates) average inflation
was 7.1 percent in the first quarter of 2007/0820 (IMF 2008).
Table 1: Consumer Price Index Trend
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Average CPI 4.4% 3.4% 3.3% 3.9% 9.3% 8.0% 7.9%Source: Board of Investment 2008
3. International & Domestic Oil Prices
International Oil Prices
The global economy has found itself in the midst of an all time oil price peak which has also
surpassed the peaks experienced during the Iranian Revolution in 1970s. This surge is having a
compounding effect on the existing macroeconomic challenges for countries whose domestic
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economy is consequentially linked with the international oil market and other product prices.
World oil average prices during 2003-04 were over 11% higher than the average prices during
2002-03.
End of the 2004-05 experienced a sharp upward swing in prices, with an increase of over 41%
compared to the average price/barrel in the preceding year. Newer peaks were reported in
price/barrel during 2007-08 when a 53.4% increase in prices was witnessed, compared to
2006-07. Overall, there has been a 360% increase in price/barrel of oil since the first quarter of
2002-03 to the end of 2007-08, with the first quarter of 2008-09 opening into even higher
average prices and etching newer records with prices over $140/barrel on a given day. Graph
shows the recent trends in world oil prices.
Domestic Prices
Being an importer of oil, the domestic furnace oil prices in Pakistan follow the rising trend
witnessed in international prices.
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4. Causes of Fuel Price Trend
A) Crude oil price and US dollar:
Crude oil is considered an investment to fall back on when the US dollar value is devaluated.
The current monetary policy could affect the US dollar to decline in value compare to major
commodities and thus it could cause a rise in demand forcrude oil as an alternative investment,
along with upward pressures in crude oil price.
There is also the demand for oil: if the monetary policy will work out as expected by the Fed, it
will improve the condition of the U.S. economy which will stimulate more businesses and
consequentially the demand for energy will likely to rise; as a result, there will be pressure
forcrude oil price to increase.
Therefore, it seems that in both cases the Feds monetary policy could further cause to crude oil
price to rise. Since, however, there are many other factors that affect crude oil price, its
premature to speculate that energy prices will increase in 2011 based on the Feds policy.
(B) Few factors affecting the cost for the customer
Let us first take a look at how the retail price of diesel fuel is computed. Several factors are
considered while computing the retail price of diesel fuel. These include the following
1. Cost of production and delivery of diesel fuel to consumers
Diesel fuel is obtained as a distillate in the process of fractional distillation of petroleum
or crude oil.
The refining, processing, procurement and distribution costs of diesel fuel include
(a) Cost of crude oil
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(b) Refinery processing costs
(c)Marketing and distribution costs
2.Operating Cost of Retail Station
Retail outlets can be owned and operated by refiners themselves or by independent
organizations that purchase diesel fuel from refiners or distributors and resell the fuel to
consumers. Operating costs of retail stations depend on various factors such as
(a) Local market conditions
(b) Location of the outlet
(c)Marketing strategy of the retail station owner
3. Federal, State and Local Taxes
In 2008, Federal excise taxes levied on diesel fuel amounted to US 24.2 cents per gallon
while State excise taxes were US 22.0 cents per gallon on an average.
The final retail price of diesel fuel reflects the costs incurred by each unit of the supply
chain comprising refiners, marketers, distributors, and owners of retail stations. The
relative share of the various components in the final retail pump price of diesel fuel
changes with time based on market conditions and also varies across different
geographical locations. The figures below illustrate the share of each cost element in the
national average retail price of diesel fuel at $4.43 per gallon as ofMay 2008 and at
$2.45 per gallon as of December 2008. It can be seen that the dip in price of crude oil
fromMay to December is reflected in the lower proportion of crude oil price in the
overall retail price of diesel fuel for December 2008.
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(C) Global Market Factors Affecting Retail Price of Diesel Fuel
Computing the retail price of diesel fuel is not as straightforward as it may appear to be. There
are several worldwide factors, political and economic, that influence supply and demand of crude
oil and diesel fuel leading to variations in retails prices
(1) Supply and Cost of Crude Oil
Global supply and demand of crude oil affects the price of crude oil, one of the most
important components in the retail price of diesel fuel.Member nations of the
Organization of Petroleum Exporting Countries (OPEC) own about two-thirds of the
estimated reserves of crude oil in the world and account for 40% of the global crude oil
production. The last few years witnessed unprecedented increase in crude oil prices
worldwide due to disruptions in crude oil supply during the Arab Oil Embargo of 1973,
the Iran/Iraq war in 1980, invasion of Iraq in 2003, unrest in Nigeria, and hurricanes in
the Gulf ofMexico in 2005. The trend of surging crude oil prices reversed with the recent
onset of the worldwide economic crisis.
(2) Worldwide Production Capacity & International Demand of Diesel Fuel
Refineries in the US have been operating at 90% of their production capacity for more
than a decade. Tight worldwide refining capacity and competing international demand for
refined distillates affect the price of diesel fuel in the US.
(3) Imbalances in Supply & Demand
Diesel fuel is primarily a transportation fuel. Problems at refineries or inadequate and
delayed imports lead to unexpected disruptions in the supply of diesel fuel. As
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inventories fall, there is competition amongst wholesalers and marketers who are willing
to bid higher for available stocks of fuel. This pushes the retail price of diesel fuel
upwards. Price spike due to insufficient supplies is a scenario commonly observed in all
commodity markets.
(4) Seasonal Variations in Demand
Prices of diesel fuel increase during the fall, dip in late winter, surge during early spring,
and again drop a bit during the summer. Demand for diesel dips in spring and summer as
gasoline consumption increases during these peak-driving seasons. In autumn, diesel
consumption increases due to increased agricultural and transportation activities before
the onset of the holiday season. Stores are known to increase inventories during the
holiday season in winter.
(5) Geographic Variations
Retail outlets that are farthest from refineries and distribution terminals have higher
diesel fuel prices to account for the costs incurred in transportation of the fuel. Local
market conditions such as number of retail outlets, traffic patterns, State and local fees
also influence the final retail price of the diesel fuel.
The figure below illustrates the change in the nationwide average monthly retail price of
diesel fuel in the US fromMay 2002 to January 2009. The rise and fall in fuel prices in
2008 is clearly the most drastic change observed in recent years.
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ULSD. This led to an increase in the cost of production of diesel fuel. This in turn
affected the retail price of the product.
(4) Fuel Taxes
Effective October 1, 1997, the federal government has imposed a tax of 24.4 cents per
gallon on diesel fuel as compared to a tax of 18.4 cents per gallon on gasoline. In
addition, each state levies a diesel tax. This ranges from 8 cents per gallon in Alaska to
32.9 cents per gallon in Wisconsin. The nationwide average is about US 22 cents per
gallon. Currently, 15 states levy a greater tax on diesel than on gasoline whereas only 6
states impose a higher tax on gasoline than on diesel.
(E) A Closer Look at the Rise & Fall in Prices in 2008
Till the beginning of 2008, booming economies worldwide led to increased consumption of
products such as diesel, gasoline and jet fuel, derived from crude oil. At the same time, world
supplies of crude oil and derived products were threatened due to political tensions in oil-rich
countries like Iran, Nigeria and Venezuela and also due to reduction in output from the aging
oilfields ofMexico, the US and other nations.
In the face of a weakening dollar in early 2008, the financial world began betting heavily in favor
of oil and other commodities. The Energy Department of the US government began to purchase
40,000 barrels per day (bpd) of sweet crude oil, which has low sulfur content and is low in
viscosity, for its Strategic Petroleum Reserve, thereby inflating demand for the product.
Consequently, we saw crude oil prices peaking at an astronomical amount of $147.50 per barrel
on July 11. The US Energy Department stopped filling the Strategic Petroleum Reserve on July
1st.
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1. Oil DependencyOil dependency or how much vulnerable a country is to price shock can be observed from the
following indicators:
Oil Self-sufficiency index:
It is the percentage change in oil production minus consumption to oil consumption. This ratio
will be negative for oil importers. If its value is -1, country has no oil production and is totally
dependent on oil imports; and a positive number means that a country is a net exporter. For
Pakistan the index has remained negative from 1990-91 to 2005-06 (Table 7). It was -0.69 in
1990-91 and became -0.85 in 1999-2000 but later on started declining given the negative growth
in oil consumption in the last five years, but still the index is at -0.79. Despite the slight decline
country is highly susceptible to high oil prices.
Oil Intensity in Energy Consumption:
Vulnerability to rising oil prices also depends on the intensity with which oil is used. The
intensity of oil use in energy consumption index measures the share of oil in an economy's
primary energy consumption. If a country relies only on oil to produce energy, the value of the
index is one; if no oil is used in producing its energy, the value is 0. Oil intensity in Pakistan has
declined over the years (see Table 7) because of switching to alternatives, more specifically gas
and to some extent coal. It can also be observed in Figure 3. This will be discussed in detail in
Section 4.
Energy Intensity:
This variable measure the energy intensity for an entire economy (measured as percentage
change in energy consumption divided by percentage change in GDP). Decrease in energy
intensity is considered as the most promising route for reducing vulnerability to oil shocks
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(Bacon and Kojima 2006). There are number of factors affecting energy intensity including
country's climate, size, level of development, as well as whether it produces and refines oil.
Countries that have colder climate consumes more energy, other things being equal, while
countries with a large oil contribution to GDP are likely to be more energy intensive. It also
varies with income levels. Its decline can be achieved moving away from energy intensive
industries; changing household consumption patterns away from activities which require large
amounts of energy (e.g., using less transportation); and involvement in those production
activities that are more energy efficient, in response to the rising input costs. For Pakistan energy
intensity is almost constant since 1990-91 to 2005-06 (Table 2). It indicates the efficiency with
which the energy is used. And the trend for Pakistan indicates no improvement in efficiency. All
the indicators discussed above are likely to be closely correlated with a country's susceptibility to
oil price shocks. One way to bring this information together is to measure the potential impact of
higher oil price on oil import costs.
Table 2:Oil Dependency in Pakistan
Oil self-
sufficiency
Intensity of
oil
Energy intensity
of Real GDP
Net Oil Imports
in terms of GDP
1990-91 -0.69 0.46 0.91 -3.131995-96 -0.82 0.48 1.01 -2.601999-00 -0.85 0.47 0.99 -3.762000-01 -0.84 0.46 1.05 -4.602001-02 -0.82 0.43 1.02 -3.73
2002-03 -0.81 0.41 0.91 -3.712003-04 -0.78 0.38 0.93 -3.182004-05 -0.79 0.36 0.99 -4.202005-06 -0.79 0.32 0.90 -5.24
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Net oil Imports in GDP: The magnitude of the direct effect of a price increase depends on the
share of net oil imports in GDP. In other words, it is an index of the relative importance of the oil
price rise to the economy in terms of the potential adjustments needed to offset it. For net
importers this ratio will be negative. Higher value of this ratio create more concerns for the
government, may be to reduce oil imports and more willingness to pass through the price to
consumer so as to stimulate a reduction in demand12. For Pakistan over the last few years, this
ratio has risen to -5.24 in 2005-06 (Table 2).
An immediate reaction to an oil shock is consumers and producers reduce their demand for oil
either by fuel switching or by switching to other goods or products. As a result import bill will
go down. This is a short term adjustment. In the long run, oil consumption can be reduced
through efficiency and changes in industrial structure and household consumption patterns. A
dynamic policy response will reduce the vulnerability of the economy (Bacon and Kojima 2006).
For Pakistan energy intensity (an indicator of efficiency) as discussed above has remained almost
constant. However, consumption of oil products has declined (may be as a reaction) in the last
few years, an outcome of fuel switching.
2. Macroeconomic EffectsAs discussed above, the magnitude of the direct effect of a given price increase depends on the
share of the cost of oil in national income, the degree of dependence on imported oil and the
ability of end-users to reduce their consumption and switch away from oil (IEA 2004).
Unless country is running in surplus, or has extremely large foreign exchange reserves, high oil
price is dealt by a reduction in total demand for all imported goods, so as to restore balance of
payments equilibrium. Higher oil prices leads to inflation, increased input costs, reduced non-oil
demand and lower investment in net oil importing countries. Tax revenue falls and the budget
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Theoretically, increasing oil prices squeeze income and demand. At a given exchange rate, more
domestic output is needed to pay for the same volume of oil imports. If the domestic currency
depreciates in response to induced payments deficits, this further cuts the purchasing power of
domestic income over imported goods. Since important trading partners are also likely to suffer
income losses, slower growth of external demand aggravates these direct impacts. Higher oil
prices also squeeze aggregate supply, since rising intermediate input costs erode producers
profits and may cause them to cut back on output. Lower profits may then result in the decline in
investment spending and cause potential output to fall over an expanded period. It is somehow
difficult to identify the factors been responsible for the high growth in Pakistan in the presence of
high oil prices. One reason might be consumers havebeen shielded by limiting the direct pass
through to final oil prices. The extensive use of fuelsubsidies in the form of PDC was helped by
strong foreign reserves position; it may havecontained output losses in the past few years.
Table 3: GDP growth in percent
1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
GDP 5.5 4.8 2.6 3.6 5.1 6.4 8.4 6.6 7.0
Source: Estimated using GDP data from IMF database.
In addition, the continued strong performance of the services sector had made contribution to the
GDP outcome. On the demand side it is the consumption expenditure that has proved to be the
main source of growth in GDP for the last couple of years, here credit flow to private sector in
the form of consumer financing played a significant role15. But since 2006-07 situation has
somewhat started changing. Private credit is showing a downward trend16 (Table 4), which may
effect GDP growth. Private sector consumed Rs. 23.533 billion from July 1st to Oct 20th,
2007against Rs. 69.870 billion in the corresponding period last year. Credit to small and medium
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enterprises is also on the decline given high interest rates and undocumented trade (Khan 2008).
With this scenario it would be difficult to maintain the high growth pattern.
High price of oil in the international market, and declining volumes of exports along with private
transfers in 2006-07 resulted in the current account deficit equal to 4.9 percent of GDP (US$ 7
billion), one percentage point higher than in 2005-06 (Table 11).
Table 4: Private Credit (annual percentage change)
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07Private Credit 4.8 18.9 29.8 33.2 23.2 17.2
Source: IMF 2006, 2008
Large scale manufacturing has missed the growth targets in the last two years. In this year, high
oil prices, gas and electricity crisis, high cost of production, declining trend in private credit and
high interest rates because of monetary tightening, would not favour industrial growth at all.
The government has consumed its budgetary target of bank borrowing (Rs. 130 billion) by
January 2008, further borrowing from banking or non-banking sources may destabilize the
financial health (Khan 2008). It is estimated that utilization of PSDP would remain significantly
lower than allocated Rs. 520 billion.
Rapidly growing economies will generally experience more rapid growth of non-oil taxation, and
hence be better able to withstand the fiscal impacts of a less than fully passing on of oil price
increase. In Pakistan, non-oil taxation is more or less the same for the last few years.
4. Balance of Payment Effect:Our petroleum imports account for 24 percent of total imports (and represented up to 44 percent
of export earnings) in 2006-07. While, in 1999-2000 the share of petroleum imports was 27
percent of total imports and accounts for 33 percent of total export earnings. Improving terms of
trade would mean that a smaller volume of exports would be needed to pay for a given quantity
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of imports. For Pakistan this ratio however is decreasing, that is more exports are needed to
offset the burden of rising import bill.
Table 5: Performance of External Sector
2000-
01
2001-
02
2002-
03
2003-
04
2004-
05
2005-
06
2006-
07*
Terms of Trade (1990-91=100) 90.96 90.83 82.07 78.68 73.60 65.01 ----
Exports in US$ (growth rate) --- 2.3 20.1 13.5 16.2 14.3 3.2
Imports in US$ (growth rate) --- -7.5 20.1 21.2 38.3 31.7 8.0
Current Account including official --- 3.9 4.9 1.8 -1.4 -3.9 -4.9
Source: IM
F 2008 * estimated
ADB (2005) has estimated the impact of high oil prices on the net import bill. By assuming 75%
rise in oil prices (approximately the increase in prices between the start of 2005 and end August),
the estimated impact on the net import bill for Pakistan is almost -4.17. Similarly, the percentage
point growth in exports that would be needed to pay for a 75% rise in the cost of imported oil is
potentially very large (i.e., 18 %) 21. This estimate is for the 75 % increase in oil prices but in
actual the prices have risen more than 100%. It means the required rate for exports growth is
much higher than this. The trend in the growth of exports can be observed in Table 5. It was only
in 2002-03, where exports growth has crossed 18 %. However, imports overall have grown quite
significantly. The government has failed to improve the export performance. However,
significant increase in imports has laid a negative impact on trade deficit. Pakistan's trade deficit
has swelled to $7.2 billion, an increase of 32.38 percent in the period July-November (2007-08)
as compared to $5.44 billion in the corresponding period last year. It is the third consecutive year
that the country is missing its export target. Trade deficit is expected to reach $9-10 billion by
the end of this fiscal year.
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Imports of petroleum group in fiscal year 2006-07 registered an increase of 12.0 percent. Within
the petroleum group, imports of petroleum products registered sharp increase of 38.6 percent
(substantial increase in furnace oil import, largely for electricity generation purpose). However,
imports of crude petroleum declined by 6.7 percent (in value terms and 10 percent in quantity
terms) because refineries operate less than their full capacity. Thus, low demand for crude oil
and so was the production of petroleum products. Current account deficit has also gone up quite
significantly (Table 5). In the current fiscal year (2007-08), from July to November, current
account deficit increased by 17 percent (US$ 4.784 billion). In the same period of 2006-07, it
was US$ 4.077 billion (IM
F 2008).
In Pakistan, in the last few years, external financial sector (that is, remittances, US aid, and
foreign inflows from FDI) has shown a solid performance23. It has helped the government in the
maintenance of the fiscal situation. However, this is only a short term solution. The government
has extensively utilized this facility but has not made substantial efforts to explore other options
to reduce trade deficit or explore areas that would have decreased its fiscal burden. Because of
this fiscal deficit has also started increasing.
5. Fiscal ImpactFuel taxes have important revenue implications for Pakistan. Oil and gas sector together accounts
for a significant share of government revenues. Taxes on Petroleum products are the largest
source of indirect revenues in Pakistan. Petroleum product prices are higher than the import
parity price because of these taxes. Petroleum products contributed Rs.120 billion to government
revenues in the form of indirect taxes (custom duty, excise taxes and sales tax) in 2006-07. It is
23.2 percent of total indirect taxes (net) 24 collected in 2006-07, while this share was only 12
percent in 2000-01. Petroleum development levy (PDL) is not included in this total. Petroleum
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development levies collected in 2005-06 were Rs 24500 million25. Adding this will make total
indirect tax revenue from petroleum products to Rs. 129.6 billion for the year 2005-06 (that is
26.6 % of total indirect taxes). The share of PDL in petroleum taxes is almost 18.9 for 2005-06.
For the fiscal year 2006-07 exact figure is not available. However, the estimated sum of
development surcharge in both gas and petroleum sector is Rs. 74 billion as compared to Rs. 54
billion last year, 2006-07 (IMF Report 2008). The taxing of fuel is one of the easiest and
relatively straight forward way to raise revenue, as consumption of petroleum products is
relatively price inelastic and income elastic, ensuring buoyant revenue as income rises and tax
rates are increased
Table 6: Petroleum Taxes (in Billion Rs.)
1999-00 2000-01 2004-05 2005-06 2006-07
Custom, Excise and Sales Tax 10.7 15.2 67.1 105.1 120
Petroleum Development Surcharge 25.4 17.9 10.6 24.5 ----
As mentioned earlier, the government has used petroleum development levy to keep the end user
price constant, given the fluctuations in the international price of oil. Even when there are price
reductions in the international market, government does not transfer it to the consumer for
domestic budgetary support and increase the PDL. Revenue from the petroleum levy almost
doubled in the first half of FY2006, as the increase in domestic prices of petroleum products put
through in September and October 2005 was not reversed when global oil prices declined in
November and December. But now due to price capping, the trend in
PDL is in the downward direction, it will have a negative effect on the share of petroleum taxes.
As far as the overall fiscal deficit relative to GDP is concerned, theoretically, smaller the deficit
(or in surplus) government might not pass the whole international oil price increase at the retail
level, as government would be in a better position to survive the fiscal implication of doing so.
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6. Impact on Exports and ImportsExports have increased by only 72% since 200203, whereas imports have increased by 227%.
This widening gap has caused the current account to persistently report a deficit, which is
growing at alarming levels. By the end of 200708, total imports stood at around $40 billion;
more than twice that of exports. The acceleration seen in imports is largely being driven by the
surge in international oil prices and the fact that Pakistan is heavily dependent on oil imports.
This is further substantiated by the graph, which shows that the oil import bill constitutes over
35% of the total import value during the last quarter of 20078 compared to 25% in the preceding
quarter. This share has increased drastically when compared to the share of 15% in early
200304. This, along with pressure from increased food prices has constantly come at a cost of
shrinking shares on other items such as Machinery and Agricultural & Other chemicals.
Source: SBP
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This certainly has had a negative impact not only on the BOP but also poses as a threat to the
level of industrialization and technological improvements to the manufacturing sector which then
translates into deteriorating exports. Imports of textile machinery have witnessed a negative
growth rate of 17% and 36 % during 200506 and 200607, respectively. Similarly, largescale
manufacturing growth too has experienced a slump with recording only 4.8% growth during
200708 as opposed to 8.6% during 200607.
Fiscal imbalances have also been created by GoPs continued policy of providing subsidy on oil
products to protect poor households and the domestic industry. The burden of subsidies in face of
ever increasing international prices rise, along with the depreciation of the rupee against the
dollar and the debt service burden is adding to the pressure on government budgets and
increasing political and social tensions.
6. Forecast for the Years Ahead
According to statistics provided by the US Energy Information Administration (EIA), the downward trend
in prices of crude oil and diesel is expected to continue in 2009 and 2010 due to low demand, weak
economy, and failed attempts by the Organization of Petroleum Exporting Countries (OPEC) to trim
production in order to support substantially higher prices. While oil consumption is expected to
continue to decline in 2009, increasing oil production capacity in OPEC and non-OPEC nations will lead
to surplus production. The imbalance caused by excess supply and reduced demand will be detriment to
the desired upward pressure on prices.
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Projected Price Trends
Crude oil prices are expected to average $43 per barrel in 2009 and $55 per barrel in 2010. The
price of diesel fuel, which averaged $2.45 per gallon in December 2008, is projected to average
$2.27 in 2009. Price trends will be largely dictated by the duration and depth of the worldwide
economic downturn, the timing and pace of recovery, and actual production by OPEC refineries.
Projected Consumption Trends
Global consumption of diesel is expected to drop by 800,000 bpd in 2009 followed by a modest
rebound in 2010 by 880,000 bpd from the previous years levels. Oil consumption is expected to
increase in countries that are not members of the Organization for Economic Cooperation and
Development, namely China, the Middle East and Latin America. However, decline in
consumption in OECD countries is likely to offset any increase registered by non-OECD nations.
The US consumed 65 billion gallons of diesel in 2007. In 2008, consumption of petroleum
products in the US fell by about 1.2 million bpd. This trend is expected to continue in 2009 with
consumption levels expected to fall by an additional 400,000 bpd. The expected economic
recovery in 2010 is likely to boost consumption of petroleum products marginally by 150,000
bpd.
Projected Supply Trends
Supply of crude oil and diesel from non-OPEC nations fell by 340,000 bpd in 2008 due to delays
and disruption of projects in the Gulf ofMexico and Central Asia. Non-OPEC supply of crude
oil is expected to increase by 180,000 bpd in 2009 and by an additional 90,000 bpd in 2010.
However, there is a lot of uncertainty pertaining to increase in supply from non-OPEC nations
since these regions face a far greater risk than OPEC nations from unexpected project delays and
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the credit crunch prevalent in the market, which could render high-cost projects unviable. The
good news is that supply from nations such as the US, Azerbaijan and Brazil is more than likely
to compensate for decline in production in non-OPEC nations.
In 2008, the US produced an average of 4.9 million bpd of domestic crude oil, a decline from the
2007 production levels by 140,000 bpd. Domestic production is likely to increase in 2009 by
over 300,000 bpd to an average of 5.25 million bpd, marking the first significant increase in
production in the country since 1991. Output is further expected to increase by 50,000 bpd in
2010 with new refineries slated to go on stream by late 2009.
It is expected that until 2010, refineries will continue to see a drop in margins due to continued
decline in the consumption of diesel and other products in the US and other parts of the world. A
lot is dependent on the rate of recovery of world economies. The faster the recovery of global
economies, the lesser would be the decline in consumption of oil and derived products such as
diesel. While all of this information should shed some light on how prices are determined, and
possible trends in the future, nobody can truly be certain what the future holds as far as oil or
diesel fuel prices are concerned. The only thing we can be certain of is that like most economic
cycles, it will surely continue to go up and down, to what extent or extremes, well just have to
wait and see.
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References
http://www.pide.org.pk/psde24/pdf/01.pdf
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http://www.pide.org.pk/psde23/pdf/Afia%20Malik.pdf
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DDV-t7yA
http://www.dieselserviceandsupply.com/Diesel_Fuel_Prices.aspx