Life after 100 USD per barrel price ?

Petrol prices: What after 100 dollar per barrel crude oil.

Brent Crude oil prices have touched a dollar 100 per barrel mark in the wake of political events in Egypt which through its Suez Canal passes quite some oil. No more are the OPEC and Middle Eastern countries the only beneficiaries of oil price increases. Russia has emerged as the largest oil producer and Exxon Mobil has posted 100 billion USD profit this quarter.

Pakistan imports a large amount of oil to the tune of 10-11 billion USD per year, which accounts for 33% of its total imports. High oil prices have damaged Pakistan’s economy very significantly, causing inflation, trade deficits, balance of payment difficulties, currency depreciation and shortage of energy and consequent loss of production.

Government of Pakistan has announced that it will not increase domestic Petrol and Diesel prices.

Recent oil price increase had to be reversed by the government under tremendous public pressure and political action. The reversal has been welcome domestically and opposed by international quarters erroneously calling it a subsidy. Energy prices are also on the agenda of talks going on between the two mainstream political parties of the country. Something good should come out of it on its own merit, if not for preventing an upcoming political impasse. Energy pricing improvements and policy changes offer some opportunity towards this end.

People were quite used to the existing oil pricing arrangement linking domestic prices with the movement in international prices. This time oil price increase came amidst back-breaking inflation and rising electricity prices. Besides, the petrol prices peaked to Rs.79.96 for gasoline and Rs.70.97 per liter , which was perhaps beyond the upper limit of consumer capacity to pay, as evidenced by the enormity of public pressure. The prices have been brought down to the December level. In today’s petroleum prices, there is a very low level of tax apart from the usual GST. There is no Petroleum Levy on Diesel due to the reversal and a very marginal one of Rs. 4.27 per liter on Petrol. Due to the preponderance of Diesel in the total consumption, the small levy on Petrol would not earn the government much except the GST. Is this a permanent price freeze irrespective of where the international prices go? What are the options with government in this respect? I am arguing for a zero-energy taxation regime .I will explain this a little later, after a little perspective on energy pricing.

Pakistan is among third tier countries along with other regional countries in a four- tier oil pricing regime prevailing in the world. In the first tier come the oil exporting developing countries of the middle east and south America , which grossly subsidize domestic petroleum products ,selling much below the crude prices, recouping probably the distribution cost only . The petrol price in Saudi Arabia is half a Riyal (Rs. 10) per liter; and similarly in other countries in this category. The second tier is of the U.S and others which marginally tax petroleum. Today’s Gasoline price in the US is 3.1 USD per gallon (Rs.66.57 per liter) as opposed to Rs 72.95 in Pakistan, and Rs 66.61 for Diesel. Petroleum Taxation in the U.S. does not exceed 15%.Third tier countries are Pakistan, India and Bangladesh etc which significantly tax Petrol. Current Petroleum prices in India are much higher than in Pakistan. Diesel costs Indian Rupees 42.06(Pk. Rs. 76 or 0.912 USD) per liter, while Petrol costs IRs 63.08(PkRs. 114 or 1.322 USD) per liter in Mumbai. Delhi prices are usually 5 IRs lower than elsewhere in India due to regional variations in taxation permitted by Indian Federalism. Diesel prices have not been raised since September 2010, while Gasoline has undergone frequent adjustments lately. Thus we see that in Pakistan Petroleum prices are considerably lower in Pakistan than India ; Indian Diesel price being 14% higher and Gasoline 56% higher.

In India , Petrol prices are allowed to remain stable for significant periods like six months or so and the international prices are not passed on to the consumer immediately as it is currently done in Pakistan. We had the same system earlier, which was replaced by the current system following criticism .As we have seen recently, a high but temporary rise in Petroleum price has the potential of causing social order and political swing. Lower prices normally go unnoticed. There is a rationale for day-to-day pricing in open uncontrolled markets. In a regulated market, one should reevaluate as to the merits of existing monthly price adjustments. Current reversal is a step towards the earlier system of variable taxation. Simply speaking, the government reduced the Oil Development Levy, a kind of a tax. In fourth tier countries come, most of the Europe which heavily tax petroleum. Today’s Petrol price in U.K, France, Germany and Netherlands are 1.45 Euro (Rs.167) per liter; a taxation rate of more than 100 %.

European taxation of Petroleum is partly a hang-over from the socialist past, wherein petroleum and cars were traditionally considered items for the rich. Today Petroleum finances public welfare expenditure in these countries. The impact is, however, only partially compensated by energy efficiency and conservation. Petroleum taxation has also been considered as a user charge of roads and transportation network. A charge of 10 cents per liter has been considered adequate for this purpose, as a recent GTZ study suggests. This comes out to Rs 8.3 per liter road tax. Infact petrol levy could be termed as Road user charge. At a consumption of 12 billion liters of consumption (85% of which is diesel), this comes out to be Rs 100.0 billion revenue stream annually. Alternatively, a subsidy at the same rate would cost the same amount. Preponderance of diesel consumption of 85% precludes any cross-subsidy option of Gasoline vis-à-vis Diesel. From the year 2009, Petroleum Levy of Rs 3.00 per liter has been charged which has been brought to zero after the price reversal. Similarly there was a constant Petrol Levy of Rs.10 per liter, which has been brought down to Rs.4.27 per liter. At crude oil prices as high as 92.40 USD per barrel, there is hardly any scope of taxation on Petroleum. Infact if it goes beyond 100 USD which is not unthinkable, GST may have to be reduced or removed , depending on the volume of crude price increase. Around the same time, we may have to consider some kind of rationing or quotas, voluntary or mandatory, however, unfashionable or unattractive that may sound.

Fortunately, the European incomes can possibly support high petrol prices and taxation. European argument does not apply in countries like ours. Secondly, Diesel a fuel used in mostly public transport and commercial vehicles used to be taxed low or none at all in many countries. Under environmental pressures Diesel is being discouraged and price differential has been reduced very significantly. In our specific situation and particularly under present conditions, this price differentiation may have to be brought back for at least next five years.

Coming to Electricity Tariff which remained somewhat affordable till 2008-09 for a variety of reasons such as reasonable exchange rate, lower oil prices, and lesser share of oil in electricity generation combined with subsidy. For several years during Musharraf period, electricity Tariff was not raised despite rise in cost of electricity generation and increasing theft. At the time of Musharraf’s exit, electrical subsidies amounted to around one rupee per unit. Falling exchange rate and rising oil prices gave rise to unfunded subsidies which gave rise to what we call Circular debt starting from a Musharraf periods level of more than one hundred billion rupees. Rising circular debt has substantially reduced working capital of utilities and Energy industries resulting in shortage in electricity production which also results in higher costs due to interest charges and higher unit fixed costs due to spread of fixed costs on a decreasing number of units produced and sold.

Thus Electricity used to be cheaper in Pakistan earlier, almost comparable to the low rates of the U.S. of an average of ten cents a unit for residential sector. For small consumer, the rates are still very low much below the cost of production. Again in Europe the Electrical tariff is very high. In several countries such as Sweden, Denmark and Netherlands, it is 25 cents (Rupees 21) per unit. A significant portion of these high prices comes from the high cost of renewable energy being promoted in these countries under high feed-in-tariff schemes.

In this rather long perspective let us revert to the zero-energy taxation regime. Simply put this means integrating the energy sector and its taxation; pooling the taxes and subsidies to balance and cancel each other. This would allow withdrawal of electrical subsidies and reduction in petroleum taxation resulting in falling petroleum prices with the rise in Electrical tariff. This may be acceptable and affordable to all parties; lower prices to consumer, no budgetary loss. Above all, it would be sellable to lenders and donors which pose a major constraint in independent economic policy making.

Petroleum taxation is a major cause of inflation in Pakistan, especially in sensitive prices index. All daily consumption items have to be transported from long distances to retail outlets and daily workers travel to suburbs which are at the city limits requiring major transportation expense. Petroleum taxation and in general all indirect taxation has been guided more by practical reasons of collectability at source or purchase and rather than much economic rationale. A marginal petroleum tax may still be maintained to cover the user charge and financing needs of the transportation sector.

The writer is a former Harvard University fellow and author of Pakistan’s Energy Development:the road ahead