Another fuel crisis might be on the cards in the wake of the Hascol scam case, as the State Bank of Pakistan (SBP) finds itself scrambling to get the banks to increase the credit limits of oil marketing companies (OMCs).
In a virtual conference organised by the SBP, the central bank’s governor, Dr Reza Baqir, spoke to the CEOs of Habib Bank Limited, Bank Alfalah, Bank Al Habib, and MCB Bank in the presence of top OMC representatives and said that the entire oil industry could not be paralysed on the pretext of the Hascol scam. The meeting became necessary because of the reluctance among top banks to provide easy lines of credit as before since the events over at Hascol.
Between 2015 to 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 non-funded financial facilities allegedly in breach of prudent banking guidelines and standards. The scam, which involved 19 banks, has been detailed before by Profit, highlighted the complacency within the banking sector as well as the malpractices of the oil sector.
This along with the statement of Dr Reza Baqir that a single OMC’s actions should ot result in the entire oil industry being paralysed makes it seem like the banks are simply taking a more cautious approach after being stung once by the OMCs. However, this is not the only reason that the banks are treading lightly.
The other reason is soaring international oil prices. While the government is picking up the slack between the international and local prices through the Price Differential Claim, the banks are sceptical regarding the ability of the OMC’s to make due payments. has also resulted in the banks raising their ears.
How it works
The price of POL in its essence is determined by the demand and supply of these commodities. If we view the historic data for oil prices it is easy to see that the price of oil coincides with the major events of the world. For example, in the last one week, the Russian invasion has resulted in the price of oil soaring through the roof. This happens in such cases because demand from major countries is increasing, so more oil is going there and then other countries have to match their prices to keep up with the country at war. During this current crisis, oil has climbed from 98$/bbl to 116$/bbl in a single week from February 25th to March 3rd.
The changes in the global market for these commodities directly affect the OMC’s since they have to import these goods and any fluctuations have a direct impact on their revenues and profitability. It is a simple matter in essence. If international prices go down, the OMCs stand to lose and if prices rise they will make gains. This gain and loss happens on the account of the inventories held by the OMC’s and refineries as required by the law.
In layman terms, the value of the inventory held by the company and the prices they can charge from customers are primarily determined by what’s happening in the international market. Now if a hypothetical company has an inventory of 100 barrels of oil, purchased at a price of 10$ per barrel would lead to a value of 1000$. But if the price dips to 8$ per barrel the value would decrease to 800$ and vice versa if price increases to 12$ the value of the inventory would increase to 1200$.
Another critical aspect is the fact that the government regulates the prices of POL products in the country. Remarkably since the announcement of Imran Khan to decrease the price of petroleum products last week by Rs10, despite the rising global prices, it creates a difference between what the actual 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 egregious case of petro-politics. This was done despite the fact that OGRA had recommended an increase of Rs10 in the price of petroleum products in view of international prices.
If the prices in international markets are high and the regulated prices low, the difference in pricing is compensated by the government to the OMC’s through the Price Differential Claim (PDC). You might wonder why the oil sector is warning of an impending upheaval in the supply chain. Although theoretically PDC provides relief to OMC’s however in reality it’s quite the opposite. Although the government guarantees the payment of PDC, it does not say when.
The government provides PDC on every litre of fuel sold making it a subsidy essentially, and the government would then pay this to the companies. The fact that the slow bureaucratic machinery causes delays in these payments to the companies, practically defeats the purpose of helping the sector. The outstanding PDC is simply parked in the balance sheets of these companies as “receivables” not addressing the short term liquidity concerns.
The credit issue
The issue with the companies is since the banks are reluctant to provide credit, there must be a quick final solution that addresses the concerns of the “cash-starved” industry. OGRA has tried to assure the oil companies that payments would be made on a rolling fortnightly basis, this would in essence cater to the immediate working capital requirements of the companies, the companies however are sceptical.
To this regard, the Secretary Petroleum Division and Oil and Gas Regulatory Authority (OGRA) chairman on Wednesday assured the oil companies that a fortnightly mechanism for payment of the Price Differential Claims (PDC) will be developed soon in consultation with the Finance Ministry.
The Oil Companies Advisory Council has protested the implementation of PDC on multiple occasions, yet the government is going back to it. In a letter from OCAC to the Ministry of Energy it expressed the ramification that PDC could have for the oil sector and the consumers as it would further add to the precarious cash flow situation of the companies.
According to the correspondence between the OCAC and MEPD, the government still owes the oil companies approximately Rs 12.6 billion on account of the previous PDC. The letters from OCAC to MEPD, highlight that the current PDC will create receivables of approximately Rs 1 billion owed to the oil companies only in the first two weeks of March 2022. This would add to the outstanding receivable of Rs 2.6 billion pertaining to November 1-4, 2021 and Rs 10 billion pertaining to 2004-2008 this would only aggravate the daunting financial challenges faced by the industry.
The oil sector is concerned about the government’s ability to make payments on time to avoid any cash flow problem. The banks also share a similar concern given the high difference between the price in international markets and the regulated prices in Pakistan, it is highly unlikely that the government has the capacity to make these payments let alone make them on time.
According to oil sector sources banks are being urged to revisit their mechanisms, improve the financing facilities for OMCs and oil refiners before production levels are affected, which can lead to a supply crisis in the country.
Our sources also emphasised the fact that banks need to facilitate this strategic industry which is also a national asset and if the national strategic asset has its operations faltered or slowed down, it will directly impact the whole economy.
What the banks have to do with this
The relationship between the banking and oil sector has been a stable and long one until the recent past. With any financial transaction or commercial activity come the banks.What are these credit limits? The SBP doesn’t really tell the banks how much they can lend to any given sector. What they can do is request the companies to accommodate the OMC’s as best they can.
And why are these credit limits important? Well, the banks have a big role to play in this whole scenario because of these limits. As explained earlier, the oil trade is very dynamic and fluid, especially when it comes to the international markets. However, what it can do is request that the companies accommodate
The refineries and OMC’s procure petroleum products from the international market. In these large scale operations credit on payments is necessary to ensure security of the supply chain. If you look at the financials of an OMC it is obvious why they have to get the banks to provide them letters of credit and running finance facilities, as the OMC’s maintain a relatively low cash/bank balance in their books and therefore rely on deferred payments to keep operating.
To explain this practice simply, a surplus of cash/bank balance on the balance sheet is idle that serves no use for the company. The extra funds may be put to good use in initiatives that would create additional revenue.
The companies that buy these commodities from the global market get a bank to sign off on their behalf with their counterparty’s bank, which would guarantee the security of payment to the suppliers bank.
Despite the fact that international oil prices have doubled in the last year or two, banks have been hesitant to extend credit limits as a result of precedence set by the Hascol debacle coupled with Imran Khan’s announcement of reduction in prices. The oil industry notified the SBP that not only the OMCs, but also the refineries, were having difficulties providing fuel.
The banks have their own concerns and risks to manage, therefore as per senior sources in the industry, the banks would only have to gain by doing more business with the oil sector. On the flip side though, the financials of the relatively smaller OMC’s in the market wouldn’t have the capacity to honour their liabilities given the current conditions in the international markets.
Furthermore the bigger players like PSO and multinationals wouldn’t have much trouble getting LC’s and enhanced credit limits in line with the global prices. According to the banking sector sources the smaller midstream and downstream sides of the oil sector would likely face difficulties. To avoid this however the government organisations have to bear the burden namely through PSO parking the debt from banks in the company’s balance sheets.
Why we might be facing another shortage
In this context, local banks must make it easier for OMCs to arrange imports to ensure the economy stays on its feet. Instead of adjusting consumer prices to import prices, the government instead slashed the prices further straining working capital requirements of oil marketing firms.
As a result, the credit lines of multiple companies in the oil sector are in dire straits. This jeopardises the ability of the OMC’s and refineries to procure fuel for the soaring demand, coupled with the fact that potential sanctions on Russian oil are feeding into the volatile trend of global prices.
The situation has been exacerbated by the fact that banks are tightening their credit limits on the basis that margins on the sale of petroleum products are insufficient to cover even the current loans when adjusted for the PDC. The bottomline being that the OMC’s and the refineries are in a very tough spot between the governments indicated PDC and the banks refusal to extend them credit facilities to import fuel.
