Are we heading towards a new oil crisis?

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Another fuel crisis could be on the cards following the Hascol scam case, as the State Bank of Pakistan (SBP) scrambles to get banks to raise credit limits for marketing companies oil (WTO).

During a virtual conference organized by the SBP, Central Bank Governor Dr. Reza Baqir held talks with the CEOs of Habib Bank Limited, Bank Alfalah, Bank Al Habib and MCB Bank in the presence of senior representatives of the WTO and declared that the whole oil industry could not be crippled under the pretext of the Hascol scam. The meeting became necessary due to the reluctance of major banks to provide easy lines of credit as before since the events of Hascol.

Between 2015 and 2020, the National Bank of Pakistan (NBP) and other private banks issued Hascol bank loans to the tune of Rs 54 billion, in funded and unfunded financial facilities, allegedly in violation of banking guidelines and standards cautious. The scam, which involved 19 banks, has already been detailed by profit, pointed to complacency within the banking sector as well as malfeasance in the oil sector.

This, coupled with Dr Reza Baqir’s statement that the actions of a single CMO should not lead to the paralysis of the entire oil industry, gives the impression that the banks are simply taking a more cautious approach after having been stung once by the CMOs. However, that’s not the only reason banks are edging their way.

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The other reason is soaring international oil prices. As the government closes the gap between international and local prices through the Differential Price Claim, banks are skeptical of OMC’s ability to make the payments due. also prompted banks to listen.

How it works

The price of POL in its essence is determined by the demand and supply of these products. If we look at historical oil price data, it is easy to see that the price of oil coincides with major world events. For example, in the past week, the Russian invasion sent the price of oil skyrocketing. This happens in such cases because the demand from the big countries increases, so more oil goes there and then other countries have to match their prices to follow the warring country. During this current crisis, oil went from $98/bbl to $116/bbl in a single week from February 25 to March 3.

The evolution of the world market for these raw materials directly affects the MOCs since they have to import these goods and any fluctuation has a direct impact on their income and profitability. It’s a simple question in essence. If international prices fall, the OMC stands to lose and if prices rise, they will make gains. This gain and loss occurs on account of inventory held by OMC and refineries, as required by law.

Simply put, the value of inventory held by the company and the prices it can charge customers are mainly determined by what is happening in the international market. Now, if a hypothetical company has an inventory of 100 barrels of oil, buying at a price of $10 per barrel would lead to a value of $1000. But if the price drops to $8 per barrel, the value will decrease to $800 and vice versa if the price increases to $12, the inventory value will increase to $1200.

Another critical aspect is the fact that the government regulates the prices of POL products in the country. Remarkably since Imran Khan’s announcement to lower the price of petroleum products last week by Rs10, despite rising world prices, this creates a difference between what the real price would be and what the regulated price is.

Now, why Imran Khan did what he did can be caused by two reasons: either he doesn’t understand basic economics or just another blatant case of petro-politics. This was done despite the fact that OGRA had recommended a 10 rupees increase in the price of petroleum products considering international prices.

If the prices on the international markets are high and the regulated prices low, the price difference is compensated by the government with the WTO through the Price Differential Claim (PDC). You might be wondering why the oil industry is warning of impending supply chain disruption. Although theoretically the PDC relieves the OMC, in reality it is quite the opposite. Although the government guarantees the payment of PDCs, it does not say when.

The government provides the PDC on every liter of fuel sold, essentially making it a subsidy, and the government would then pay it to the companies. The fact that the bureaucratic slowness results in delays in these payments to companies virtually defeats the purpose of helping the sector. The outstanding amount of the PDC is simply parked on the balance sheets of these companies as “receivables” not responding to short-term liquidity problems.

The credit issue

The problem with business is that since banks are reluctant to extend credit, there must be a quick end solution that addresses the concerns of the “cash-strapped” industry. OGRA has tried to assure oil companies that payments will be made fortnightly, which would essentially meet the companies’ immediate working capital needs, but the companies are skeptical.

In this regard, the Petroleum Division Secretary and Chairman of the Oil and Gas Regulatory Authority (OGRA) assured oil companies on Wednesday that a fortnightly payment mechanism Price Differential Claims (PDC) will be developed shortly in consultation with the Ministry of Finance.

The Oil Companies Advisory Council has repeatedly protested against the implementation of the PDC, but the government is coming back to it. In a letter from OCAC to the Department of Energy, he expressed the ramifications PDC could have for the oil industry and consumers, as it would further add to the companies’ tight cash flow situation.

According to the correspondence between the OCAC and the MEPD, the government still owes the oil companies about Rs 12.6 billion because of the previous PDC. Letters from OCAC to MEPD point out that the current PDC will create claims of around Rs 1 billion owed to oil companies in the first two weeks of March 2022 alone. This would be in addition to the outstanding Rs 2.6 billion rupees as of November 1. -4, 2021 and Rs 10 billion for 2004-2008 would only compound the daunting financial challenges facing the industry.

The oil sector is concerned about the government’s ability to make payments on time to avoid any cash flow problems. Banks also share a similar concern given the large difference between the price in international markets and the regulated prices in Pakistan, it is highly unlikely that the government will have the capacity to make these payments let alone make them on time. .

According to sources in the oil sector, banks are urged to review their mechanisms, improve financing facilities for WTOs and oil refiners before production levels are affected, which may lead to a supply crisis in the country.

Our sources also highlighted the fact that banks need to facilitate this strategic industry which is also a national asset and if the national strategic asset sees its operations weaken or slow down, it will have a direct impact on the whole economy.

What banks have to do with it

The relationship between the banking sector and the oil sector has been stable and long until the recent past. With any financial transaction or business activity come banks. What are these credit limits? The SBP does not really tell banks how much they can lend to a given sector. What they can do is asking companies to accommodate MOCs as best they can.

And why are these credit limits important? Well, banks have a big role to play in this whole scenario because of these limitations. As explained earlier, oil trading is very dynamic and fluid, especially when it comes to international markets. However, what it can do is ask companies to accommodate

Refineries and OMC obtain their supplies of petroleum products on the international market. In these large-scale operations, payment credit is necessary to ensure supply chain security. If you look at a CMO’s financial statements, it is obvious that banks must provide them with letters of credit and funding facilities, as CMOs maintain a relatively low cash/bank balance on their books and are therefore dependent on payments deferred. to continue to operate.

To simply explain this practice, an excess cash/bank balance on the balance sheet is dormant and serves no purpose to the business. The extra funds can be put to good use in initiatives that would create additional revenue.

Companies that buy these commodities on the global market obtain a bank signature on their behalf with their counterparty’s bank, which would guarantee security of payment to the supplier’s bank.

Despite the fact that international oil prices have doubled over the past two years, banks have been reluctant to extend credit limits due to the precedent set by the Hascol debacle coupled with Imran Khan’s announcement of a price reduction. The oil industry informed the SBP that not only the OMCs, but also the refineries, were having difficulty obtaining fuel supplies.

Banks have their own concerns and risks to manage, therefore, according to leading industry sources, banks stand to gain by doing more business with the oil sector. On the other hand, however, the relatively smaller OMC financiers in the market would not have the capacity to service their debts given the current conditions in the international markets.

Moreover, big players like PSO and multinationals would not have much trouble getting LCs and enhanced credit limits in line with global prices. According to sources in the banking sector, the small midstream and downstream sides of the oil sector are likely to face difficulties. To avoid this, however, government organizations must bear the burden, including through PSOs that lock bank debt onto corporate balance sheets.

Why We Might Be Facing Another Shortage

In this context, local banks must facilitate the organization of imports by the OMC to ensure the maintenance of the economy. Instead of adjusting consumer prices to import prices, the government instead reduced prices, which further strained the working capital needs of petroleum marketing companies.

As a result, the credit lines of several companies in the oil sector are in dire straits. This jeopardizes the ability of CMOs and refineries to source fuel for growing demand, coupled with potential sanctions on Russian oil fueling the volatile global price trend.

The situation has been exacerbated by banks tightening credit limits on the grounds that margins on the sale of petroleum products are insufficient to cover even outstanding loans after adjusting the PDC. The bottom line being that the WTO and the refineries are in a very difficult position between the governments indicated by PDC and the refusal of the banks to grant them credit facilities to import fuel.

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