Govt wakes up to circular debt in the gas sector. Why does it matter? 

The government has finally jumped into action to address the spectre of growing circular debt in the gas sector. 

The government has formed a committee to devise a comprehensive settlement plan to map, manage, and eliminate the gas circular debt in an effort to secure the necessary funding from the International Monetary Fund (IMF).  

The IMF highlighted in its last Pakistan report that circular debt in the gas sector stood at an alarming Rs 720 billion — and that figure doesn’t fully cover the situation as it stands currently.

This prompted the IMF to request that Pakistan raise gas tariffs for consumers in order to recoup a portion of the debt.

Even though Prime Minister Shehbaz Sharif earlier this week directed concerned officials not to impose any further burden on the country's gas and electricity consumers, it may be the only way to salvage the struggling economy. 

Gas circular debt ?

The gas industry circular debt is a relatively new situation caused by rising LNG costs and delays by the government in announcing the new and higher tariff consistent with the international gas price hikes. Another contributing factor is the government's inefficient utilisation of this commodity coupled with untargeted subsidies. 

The fundamental cause of the circular debt is the unpaid government subsidies intended for residential and export-oriented consumers for the consumption of LNG. This has hampered Sui Northern Gas Pipelines (SNGPL) and Sui Southern Gas Company's cash flows (SSGC) as they are not able to recover the actual cost of importing LNG from their respective customers.

To make the point clear, LNG costs a lot more than domestically produced gas, therefore naturally the price should be set at a level that would allow the recovery of the costs. But that is not the case as the government diverted the expensive LNG to domestic consumers which cannot afford to pay for it. 

This has resulted in ballooning receivables from the twin gas distributors on the balance sheets of energy exploration corporations, primarily the Oil and Gas Development Company (OGDC) and Pakistan Petroleum Ltd (PPL).

To summarise it, the government has not paid up the subsidy amount it owes to SNGPL and SSGC for providing gas at lower rates than what it actually costs. The debt is parked within other state owned enterprises, as is the common practice of the government. 

Even though the government really hasn't formally defined what constitutes circular debt in the gas sector, experts use Sui receivables in the accounts of OGDC and PPL as a proxy to gauge the amount of circular debt. 

Due to dwindling indigenous natural gas supplies, Pakistan's reliance on liquefied natural gas (LNG) has grown in recent years. As a result, the stock of circular debt in the gas sector has expanded substantially during the last three years.

The recent war in Ukraine also shot up LNG prices in the international market through the roof, coupled with rupee depreciation against the dollar, it spelled disaster. These two factors have had a huge impact on inflating the domestic gas circular debt to alarming levels. 

What is the government doing about it? 

The government announced the formation of a committee on Wednesday to undertake the task of settling the gas sector circular debt, empowering the committee to make meaningful decisions will be another challenge in itself. 

As per the latest information the committee's Terms of Reference (TORs) include a complete mapping of the gas sector circular debt stock as of June 30, 2022, differentiating principal amount of debt, surcharges, and penalties.

The committee's other TORs are to devise a comprehensive circular debt settlement plan based on cash/non-cash release adjustments and to determine the legal and procedural prerequisites for implementing the settlement plan.

Earlier this year the PTI government passed the “Weighted Average Cost of Gas (WACOG)” to address the woes of the energy sector. Through this pricing mechanism the government would proportionally include the cost of LNG along with the cost of local gas into the domestic price of the commodity, thereby having a price that represents the actual cost. 

However, in its report regarding WACOG, brokerage house Arif Habib Limited (AHL) at the time also stated that, “perhaps, the most impacted would be the residential consumers who form 44% of the total gas sales mix of the country. However, we believe the lowest tariff bracket (which makes up 40% of the residential demand and has a current tariff of Rs121/mmbtu) will continue to be shielded through a targeted subsidy”. 

This continues to be the case as the country’s reliance on LNG increases. This is due to depletion of local reserves, of course, and has to therefore, be diverted to the domestic market at a price lower than the actual costs. 

While talking to Profit, a senior professional in the LNG industry, Saad Ahmed Qazi, said that there is “one and only one way to end the gas sector circular debt problem: Charge the end consumers the actual cost of the gas they use.”

“The issue is simply arithmetic,” he said, explaining that “if a commodity costs you $10 and you sell at a price of $6, you will incur a loss. That loss will compound over time- we call it the circular debt. Whether that loss is in the form of unaccounted for gas, subsidies, or simply refusal to increase the price, it is irrelevant.”

 

Saad further went on to add that, “If the government is not able to recover the costs it takes to import the gas, it will inevitably end up as circular debt in the value chain in one form or another”.  

However it might be unlikely that this mechanism would be used given the resistance at a provincial level. The argument of the provinces is simple: Why should they bear the cost of LNG being primarily supplied to consumers in Punjab as they have enough production of gas to meet their required provincial demand. 

Alternatively, for long-term sustainability, incentives for supporting local gas exploration and production operations along with encouraging international players to participate in the domestic market is essential, according to Pak-Kuwait Investment Company Ltd Head of Research Samiullah Tariq.