his report focuses on the analysis of the Oil Marketing sub-sector of the Fuel & Energy sector in Pakistan, with special reference to the two leading Oil Marketing Companies (OMCs) namely Pakistan State Oil Limited (PSO) and Shell Pakistan Limited (SPL). There are other oil marketing companies – Caltex Oil Pakistan Limited and Mobil Askari Lubricants but they are relatively small as far as market share is concerned.

Pakistan State Oil Ltd:

(PSO) is a public sector company primarily engaged in oil and lubricants marketing. The principal activities of the company include supply of fuel to power plants, industries, the armed forces, airlines and servicing of the fuel needs of the transport sector. In 1974, four private companies were merged into one state run oil marketing company, called Pakistan State Oil Limited. These 4 companies from which PSO was formed were Pakistan National Company, Premier Oil Company, Dawood Oil and ESSO.

The competitive advantages of PSO are:

• Market Leader

PSO is the market leader in all types of fuel and lubricant oil. It has a 72%[1] market share of the total market for POL products. In the lubricants market, it has a 31% market share which is just more than the illegal/informal sector has and slightly more than what SPL or Caltex has. The company dominates in the regulated sector but not  in the non-regulated area where there is much more for improvement as it only contributes 3% towards its total sales volume. PSO has 3475 retail outlets while its closest competitor SPL has only 1182 outlets.. This position obviously gives PSO a stronger position for its operations.

 

• Investment in Infrastructure

PSO dominates its competitor in sheer size. PSO has storage facilities all over Pakistan – at 36 locations with a capacity of 552,000 tons. SPL only has 65,000 tons storage capacity. PSO is capable of delivering uninterrupted oil supplies to their customers anywhere in Pakistan. Storage Facility at Pipri Marshalling Yard was completed so as to facilitate supplies to IPPs. Also Computer networking of all depots etc has started. Booster Pumping Station at FOTCO Jetty was also initiated as well as a number of other projects – pipelines included which give it a clear and distinctive edge over the competitors – especially Shell.

• Fuel Supply Agreements

PSO is the only provider of FO to all the IPPs and CPP (Captive Power Projects). Since most of these are long term projects (excess of 20-25 years), the FSA has been signed for the entire duration of the project. This gives PSO a steady source of income and sales revenue.

PSO

Sales

 

• PSO’s current market sales break up is as follows:
• Industries, Powerhouses & Railways             55%
• Aviation                                                          3%
• Retail Outlets                                                  32%
• Pak Army and Navy                                       1-2%
• Small Segments                                               8%

 

Marketing Procedures Adopted

PSO’s Environment is intrinsically homogenous. The customers are industries and the retailers of petrol and other fuel oil. The products are relatively homogenous and differ in the way they provide their services. All petroleum products are acquired from the refining of the crude oil and the refined oils are obtained at different temperatures.

All the three multinational companies operating in the industry provide the same products. The difference lies in the way they provide these services. Shell and Caltex being Multinationals have a greater commitment and focus on the quality and customer satisfaction and hence they are more sensitive to the consumer needs and wants respectively.

For example, during the recent World Cup, Shell provided up to date score by installing a score board at their revamped retail outlets. They also provided free windshield washes when the customer is waiting for a filling of the petrol.

 

Presence of Automated Pumps on Sales

 

Automated pumps have been installed at most of our retail outlets. This was done after the competitors had already done so that nearly all the urban outlets. The major advantage of the automated pumps is that it gives the customers the added benefit of being sure about how much quantity of fuel is he/she receiving. This also facilitates the payment of the charges.

 

Caltex first did the introduction of the pumps in 1990, and after that by Shell introduced them in 1993.  This was followed suit by PSO and later adopted uniformly. The automated pumps provide a sense of security to the customer; he is assured that he is getting the right amount of petrol.

 

 

Shell Pakistan Limited (SPL):

 

Shell Pakistan Ltd. is a public sector company primarily engaged in oil and lubricants marketing.

Until March 1993, Shell operated in Pakistan as Pakistan Burma Shell Ltd. Then Burma Castrol sold its 24% stake in PBS to Shell International Petroleum plc. This increased Shell International’s stake to 49% and after buying 2% from the local market, they increased it to 51% and took over PBS and renamed it Shell Pakistan Ltd.  Shell has the following competitive advantages:

 

• Market Niche

 

While PSO has a number of retail outlets and out does SPL in volume terms, SPL has carved out for itself a cozy niche. Its operations are focused on lubricants, industrial chemicals, and aviation fuels. Here the margins are high but the volumes are low. SPL’s greatest market share is in 100LL fuel, which is used in small jet air crafts and helicopters[2]. It has 100% of this market. SPL’s market share in Mogas is now up to 44%, 32% for diesel and 42% for retail lubricants[3]. The Chemical business has a market share of 30-40% and supplies a variety of industrial chemicals[4]. Despite the fact the SPL only has 1182 outlet as compared to 3000+ than PSO owns, it must be noted that SPL operated more in the non-regulated sector than in the regulated sector. Thus SPL can increase its margin quite substantially.

 

• Better Management

 

SPL’s management is better off, aggressive and more professional than PSO’s. If the oil marketing industry were to deregulate tomorrow, SPL would fancy having a chance to improve on its market share status. SPL has consistently been achieving high growth through hard work and excellent cost and quality control which can give it the thrust needed to boost surpass PSO market share.

 

Caltex Oil (Pakistan) Limited

 

Caltex has operated in the sub-continent since 1938 and established its subsidiary Caltex Oil (Pakistan) Limited (COPL) in 1947. Apart from the main oil storage facility at Karachi, COPL has 13 Depots throughout the country.
COPL’s Retail network consists of over 500 outlets located in all Headquarter towns and most strategic locations. COPL also has a Distributor’s network which caters to the demands of the Industrial as well as the Agricultural sector. It has recently installed their first CNG facility at the Company managed retail outlet at Islamabad.
COPL is the only Oil Marketing Company which operates its own tank truck fleet in major cities of the country. This arrangement guarantees not only supply reliability but meets the customer requirements of quality and quantity of product.
COPL has the following strategic advantages:

 

• COPL was the first to introduce many modern concepts in the oil industry in Pakistan. Recently, a state-of-the art computerized lubricating oil blending plant has been set up and commissioned at COPL’s West Wharf Terminal, Karachi. Its modern testing laboratory fully equipped with the latest equipment coupled with fully documented procedures is the only ISO 9000 accredited Oil Testing Facility in the country.
• In the refueling of International Airlines at Quaid-e-Azam International airport, Karachi, COPL became the first and only company in the country to have its refueling facility, equipment and systems accredited with ISO 9000.
• COPL took the lead in renovating, revamping and modernizing its Retail network bringing the standards in line with its International image in order to provide quality products and services to our valued customers.

COPL has made a major investment in its organization hiring over 150 MBA’s (half of whom are women) and other highly qualified staff needed to manage a modern oil marketing company today.

Caltex Petroleum Corporation, of which Caltex Oil (Pakitastan) Limited is a part, is a major International Oil Company, created in 1936 as a joint venture between two major US oil companies, Chevron Corporation and Texaco Inc. It has been called the most successful joint venture in corporate history.
Caltex is a diverse organization operating Refineries, Refined Oil Terminals, Lube Blending Plants, LPG / storage / marketing facilities and retail outlets. Caltex companies refine, manufacture and market a wide range of petroleum products in Asia, Africa and Australia. Caltex has products, leading edge technology and engineering wiht 17,500 retail outlets in 64 countries of the world. Its Corporate Headquarters is located in Dallas, Texas.

STRUCTURE OF THE F & E SECTOR

 

The Fuel & Energy (F&E) sector in Pakistan is made up of the Oil and Gas Exploration companies, Oil Refineries, Oil and Gas Marketing companies, Captive Power Plants and Independent Power Projects. Major companies in each sub-sector are as follows:

 

Table 1 :- F&E Sector Structure

Oil and Gas Exploration companies	Pakistan Oilfields, Mari Gas, SSGC, SNGPL
Oil Refineries	Attock, National, Pakistan Refinery
Oil and Gas Marketing companies	PSO, Shell Pak, SSGC, SNGPL, Mari Gas
Captive Power Plants	WAPDA, KESC
Independent Power Projects	HUBCO, Japan Power

 

Most of these sub-sectors in the F&E sector are oligopolistic. There are a few limited numbers of companies in the oil and gas exploration side – Union Texas Pakistan (UTP) and OGDC are the main ones which are not listed companies and they supply more than 60% of the oil produced in the country. In the gas exploration side, there are only a few small companies but majority of the gas produced is by OGDC, Mari Gas, PPL and UTP. There are only 3 refineries at present but they will increase once Pak-Arab Refinery Company (PARCO) and Pak-Iran come online. Similarly in the oil marketing sector there are only 3 major companies with Mobil and other new entrants.  The only sub-sector, which is not restricted to a few companies, is the electricity generation sector – IPPs and Captive Power Projects.

 

PAKISTAN OIL SECTOR – A BRIEF SYNOPSIS

Oil is the primary source of energy and met 45% of Pakistan’s energy consumption needs in 1998[5]. Local production has increased to 58000 bpd – 18% of our total requirement of 350,000 bpd[6] leaving us with net imports of 290,000 bpd. These are met through imports of $1.1 billion in 1998-99[7] which are forecasted to increase to around $2 billion in the current year on account of higher international oil prices as well as higher demand for oil and other POL products.

 

Pakistan’s recoverable oil reserves of crude oil on March 31, 1999 were estimated at 238 million barrels. The average crude oil production at the end of the 3^rd quarter of FY 98-99 was 55,703 bpd with the southern area more dominant. The main oil producers are OGDC and UTP with some other smaller companies.

 

In order to boost self-reliance in this sector, GOP has offered various incentives such as duty exemptions and international pricing. The area under exploration was divided into 3 regions based on risks and capital requirements and the rate of return on them were also fixed respectively. A new package for offshore oil exploration has also been prepared. Shell and TotalFina have both signed agreements with the Ministry of Petroleum in this regard. At the same time, the LPG industry has also been liberalized to encourage investment into that sector.

DEMAND

Pakistan’ s energy consumption has expanded at a CAGR of 6% since 1991[8]. Over the last 5 years, thermal power generation has almost doubled including about 4000MW from the IPPs[9]. The higher power sector demand (16% pa growth) has been the main driver for the increase in oil consumption. Overall POL consumption growth rate is forecasted to remain in the 6-8% range. This in turn augurs well for the Oil Marketing Companies (OMCs) – a fact proven by the rising share prices and profitability of the companies.

POL products’ consumption by sector.

 

Demand for POL products also greatly exceeds the country’s refining capability so the majority of oil imports are finished POL products rather than crude oil. Pakistan’s consumption of refined POL products is 3 times the refining capacity of the country. To reduce the import bill and increase the domestic refining capacity, the GoP has planned to set up additional refineries. Major ones include PARCO refinery at Multan which will be capable of refining 100,000 bpd, and Pak-Iran Refinery at Khalifa Point, Baluchistan. The Pak-Iran refinery would have a capacity of refining 130,000 bpd of Iranian crude but the project is being delayed due to snags and inability of financial close. Another refinery, the PSO-Hyundai refinery, has already been indefinitely postponed because of difficulties in financial close and Hyundai’s insistence on 25% USD return.

 

 

SUPPLY

 

During July-March 98-99, total energy supplies amounted to 41.166 million barrels of crude oil – 25.9m imports and 15.26m of local crude extraction[10]. The amount of POL products consumed during July-March 98-99 totaled 12.37 million tonnes – 7.5m tonnes of imports and 4.87m tonnes of local production[11]. These are greater by 6% of last years’ consumption levels.

 

During the period July-December 1999, imports of petroleum crude and petroleum products have increased to $1200 million from $665 million in the corresponding period last year showing an increase of 86%. The quantity of the products imported went up by 81% – petroleum crude went down by 6.7% but POL products went up by 16.1%. Prices have increased as well – crude increased by 81.5% while POL products increased in unit value by 60%.

Refining

Presently, three refineries are operational in the country. They are:

• National Refinery (2.8 million tonnes capacity)
• Pakistan Refinery ( 2.4 million tonnes)
• Attock Refinery ( 1.1 million tonnes)

 

The refineries operate on the formula of guaranteed return- minimum return on 10%  on capital and maximum return of 40%.

 

Problems Identified With the Refining Sector:

• Regulated nature of the Industry: cap on maximum returns
• Close Proximity to Middle Eastern Countries makes setting up refineries in Pakistan an unattractive proposition. Middle Eastern refineries, mostly vertically integrated, can exist in an environment of low margins but Pakistani refineries have an uncompetitive cost structure due to low economies of scale
• Import Parity pricing policy formula has resulted in discriminatory duty structure and needs to be re-examined to ensure product prices of the domestic refineries equate with the landed cost of deficit product imports
• 5% turnover tax harms refineries as the industry is characterized by high turnover and low margins.

 

(m metric tonnes)	1996-97	2000-01	2006-7
Oil Products Demanded	16	21.07	26.5
National Refinery Limited	2.8	2.8	2.8
Pakistan Refinery Limited	2.4	2.4	2.4
Attock Refinery Limited	1.1	1.1	1.1
Parco Refinery	—-	4.5	4.5
TotalDeficit	6.39.0

 

INDUSTRY PROFILE

HISTORICAL PERSPECTIVE

 

The Oil Marketing sector in Pakistan has been largely dominated by the Government over the last 2 decades. Many privately owned oil companies once operated in the oil marketing sector but the nationalization of the companies (which formed PSO) in 1974 restricted further private activity in this sector. Lately, the GoP has emphasized on deregulating the oil marketing sector and we have seen more private companies entering the market – Shell Pakistan, Caltex and Mobil Askari being a few of them.

 

 

Since the public sector was mostly responsible for the supply of oil in the country, there was not much emphasis on margins rather on operations. It was only in 1993 that the government decided on revising the margins upwards from 0.6% to 1.4%. This made the sector more attractive to the private investors and made possible petroleum related infrastructure. The margins were once again revised in 1995-96 to 1.9%[12] and further increases were promised if the oil marketing companies were to invest more in storage, transport and other infrastructure developments. These margin increases have not materialized so far and do not look to do so until the budget for FY 2000-01. The margins on various categories of products are discussed later on.

ENVIROMENTAL ANALYSIS

 

ECONOMIC ELEMENT

 

International Oil Prices

 

The industry is heavily import dependent. We import around 60% of the oil requirement of the country – in the form of crude as well as refined and finished POL products. In July-March 98-99 our petroleum imports totalled $1.1 billion while it is scheduled to exceed $2 billion this year. During the period July-January 1999-2000, we have imported 6,558,783 tonnes of petroleum products at a cost of $1 billion[13]. The percentage change in quantity is 14.40 percent while it is 89.08 percent in value – reflecting the higher international oil prices. The GoP has linked the prices of refined local petroleum to the mean Singapore FOB prices[14]. Thus higher international prices mean higher local prices – the GoP is committed to reviewing oil prices on a quarterly basis.

 

Exchange Rates

 

The oil prices in the country are automatically hedged against any devaluation. If the PKR were to devaluate, then the GoP will revise oil prices upward to counter the loss in PKR value. This may not be very relevant in the short term since the PKR is very stable at Rs. 51.90 but in the long term in which further devaluation may not be unavoidable, this provides a hedge against higher costs (which are passed onto the customers).

 

Current Economic Conditions

 

A major portion of the POL demand is from the industries – if they were to suffer then so would the OMCs, this being especially true for the Power Sector. If more IPPs switch over to using natural gas (to lower costs and hence tariffs), this will have a greater adverse impact on the sales of Furnace Oil. PSO would be more exposed to this risk than would other OMCs – since most of the Fuel Supply Agreements are with PSO. KESC is gradually being shifted to a gas-fired turbine[15]. There are two more 2 large scale power plants – HUBCO and KAPCO which might be shifted to gas since they are currently having price reduction talks with the GoP.

 

There are also suggestions by certain quarters that the cement industry be also made to convert to using gas as the fuel component. The fuel is a major cost component in the cost of manufacturing. As stated above, PSO is more exposed to this risk than any other oil marketing company.

 

With the recent pick up in the industries and expectations of higher growth and development in the future – as well as rising international oil prices – the imports of POL products have gone up in the current year. During July-January 1999-2000, we imported 6,558,783 tonnes of petroleum products at a cost of $1 billion while the imported quantity last fiscal year was 5,733,288 metric tonnes costing $532.53 million. The percentage change in quantity is 14.40 percent while it is 89.08 percent in value. The import of 2,582,001 tonnes of petroleum crude during this period cost $ 436.101 million as against the 2,686,283 metric tonnes valued at $ 241.612 million during the corresponding period last year. The import decreased by 3.88 percent during this period but its value increased by 80.50 percent.

 

LEGAL/POLITICAL ENVIRONMENT

 

Regulation

 

Until recently, the oil marketing companies were functioning under a strict regulated environment so much so that to establish new retail outlets they had to seek GoP approval. These restrictions are gradually being removed so as to deregulate the market slowly. The lubricant industry is very much deregulated and the margins are set by the OMCs themselves. However the strict licensing requirements required for setting up an oil marketing company remain and at present the GoP is discouraging any new entrant into the oil marketing sector.

 

The oil prices in the country are regulated and there is a fixed margin that both the dealer and the distributor (the OMC) get – currently the average distribution margin is 2% while the average dealer margin is around 1%. The regulated environment favours PSO – their complacent management is still able to reap in profits but the professional management of SPL prefers a de-regulated environment where they can cut down on costs to increase profitability.

 

COMPETITORS

In the fuel marketing sector there are presently only 3 companies operating – Shell Pakistan Ltd. (SPL), Pakistan State Oil (PSO) and Caltex Pakistan. The number of retail outlets for these OMCs are as follows:

 

Table 3 : No. of Retail Outlets[16]

 

	PSO	Caltex	SPL	Total
Karachi	154	59	98	311
Punjab	1980	225	614	2819
Sind-Ex-Karachi	501	56	182	739
NWFP	501	60	192	753
Balochistan	339	30	96	465
Total	3475	430	1182	5087

 

The greatest competition that PSO faces is the lack of professional management. SPL and Caltex are both foreign owned companies. They have better management practices and are better able to control costs and market their products effectively so as to increase profits over time. PSO, on the other hand, is very complacent and casual in its management approach. It would have lost a great number of Fuel Supply Agreements (FSA) with the IPPs but since it was GoP controlled, PSO got preferential treatment.

 

SPL ‘s aggressive marketing has become a real thorn for PSO. They have gained valuable market share by aggressive promotion in serving the upper end of the market. PSO has recently retaliated by revamping their outlets and launching a new corporate logo – both have received highly favourable responses and they have finally awakened up to the potential of increasing their market share through aggressive marketing.

 

MAJOR CUSTOMERS

The major customers of the oil marketing companies are:

• Industries, Powerhouses and Railways
• Aviation
• Retail Customers
• Pakistan Government and Armed Forces
• Others

 

SPL serves mainly the upper end of the market – aviation and retail customers as well as focusing strongly on lubricants and some sales on major industries. SPL has between 32% – 44% market share in the retail sector for various products[17]. In 1998, the Chemical Business of SPL earned it 22% share in the total earnings of SPL. Similarly, SPL is also active in certain chemical business – solvents, aromatics and polyols etc.

 

PSO, on the other hand, is mostly involved in low margin sales to industrial consumers. Sometimes, it also packages its lubricants with these sales. All GoP dealings as well as fuel to the armed forces is supplied by PSO.

 

 

PSO has a number of Fuel Supply Agreements (FSA) with the power producers. Major FO purchasers (all from PSO) are:

 

 

Table 4 : IPP FO Demand

Project Name	Qty Req. Mln Tons
Hubco	1.91
Japan Power	0.18
AES Pakistan	0.51
Kohinoor	0.18
Rousche Power	0.62
Tapal Power	0.18
Southern Electric	0.17

 

 

The industries sector also uses LDO (Light Diesel Oil), Kerosene amongst fuel oils and lubricants and greases for the machinery apart from the FO.

 

PSO dominates in most market segments and controls 76% of the total POL market – SPL and Caltex control 19% and 5% respectively[18]. However these numbers are misleading. PSO dominates heavily in the regulated petroleum products’ market, while its market share in the unregulated petroleum products’ market is much less.

 

Table  : Regulated Products vs Non-Regulated Products[19]

	PSO	Caltex	Shell
Market Share – % Regulated Products	77	5	18
Market Share – % Unregulated Products	57	5	38
Regulated Products % of Total Sales	97	95	91
Non-Regulated Products % of Total Sales	3	5	9

 

Note that even though PSO controls 77% of the regulated market, it only controls 57% of the unregulated high margin products (lubricants etc) while SPL almost doubles its regulated market share in the unregulated sector – from 18% to 38%. In terms of volumes sold, PSO sells only 3% of its sales volume in the unregulated sector while SPL sells 3 times as more – 9% of its total sales volume in the unregulated sector. This represents significant earnings potential for SPL since they can make up for their small market share by selling more high-end lubricants. These companies also face stiff competition form Mobil which also sells high margin lubricants.

 

THE PETROLEUM POLICY OF 1997 AND ITS IMPACT ON OMCs:

Although the Petroleum Policy 97 was comprehensive, the following section highlights some of the measures that affect the Oil Marketing Companies.

 

1. The commission of the OMCs and dealers will be reviewed and adjusted annually by the GoP, if necessary, to enable them to invest in the construction of commercial POL storage areas, logistics and other facilities.

 

The increase in the distribution margins of the OMCs will only serve to improve their profitability and increase investment. The current margins are:

 

HOBC	2.32 %
MS	2.17 %
Kerosene	1.36 %
HSD	1.53 %
LDO	1.36 %
Furnace Oil	1.65 %

 

On average, the margins come out to be around 2%. There is a need to bring them at par with the world average of 4-5%. The GoP is committed to do so but has not taken any concrete steps till now.

 

Instead, as the international oil prices kept on falling, the GoP delayed in revising margins (as well as delaying any reduction in POL prices) so that they could pocket the difference in the prices as development surcharge. This yielded higher revenues for the GoP and they used it to bridge the budget deficit. Worsening economic conditions of the country will continue to mean that the GoP will not revise margins and use this to finance the deficit. At the same time, under pressure of an imminent deregulation, both PSO and SPL have intensified their capex and invested a lot into infrastructure development. Thus the GoP got what it wanted without having to pay anything while the OMCs have only been spending funds and not getting anything in the kitty – except future strength if the industry deregulates.

 

2. A storage surcharge of Rs. 0.10 per litre will be imposed on POL products for construction of strategic storage facilities by either NLC or by the OMCs so that GoP can maintain a 45 days cover of oil inventory.

 

3. Lubricants will remain free from price control. No permission will be required for establishing lube blending, reclamation, grease and wax plants except registration for quality checks.

 

Since lubricants are not regulated, the margins on them can run up to 20%. Due to this, they continue to remain a very profitable venture/product for any OMC. PSO supplies bulk of its lubes to the industries in the form of machinery lubricants while SPL and Caltex cater mainly to the automobile sector. Mobil has also joined in the fray with its high-class automobile and industrial lubricants.

 

SPL, with its professional management has focused on this and they claim to hold 17% of the total lubricants market[20]. The lubricants thus have a great impact on the company’s profitability and provide a good avenue for a company to attack and increase profits. The sector has already seen Mobil entering and exploiting this high margin area. PSO has a small presence in the high margin lube area as most of its lubes are of low-quality industrial machine lubes and sometimes these are even served complimentary to the main product. Thus SPL is better positioned than PSO to take advantage of the deregulated lubricant industry and profit from them.

 

To counter the threat from Shell, Pakistan State Oil and Mobil Askari Lubricants Ltd have formed a marketing alliance for meeting requirement of industrial sector in the country. The alliance will have Pakistan State Oil’s vast marketing resources and nation-wide network of storage and supply of fuels in addition to Mobil’s complete range of quality industrial lubricants, engine builder relationships and technical services. The industrial customers will now enjoy a wider variety of products and services of Pakistan State Oil and US-based Mobil, right at their doorsteps. This is beneficial to both Mobil and PSO – Mobil gains greater market share and PSO gets higher acceptance and perception of quality for its lubricants.

 

4. Refineries can sell their product to any oil marketing company or they can set up an oil marketing company of their own.

 

The most important policy that affects the oil marketing companies is that the refineries can sell their output to any OMCs or they can set up one of their own. PARCO has already announced its intention to set up an oil marketing company and the GoP is said to have lent its full authority to PARCO to negotiate in the oil market. Also Attock Refinery has also started its own oil marketing company but it only acts on a limited scale. The other 2 refineries, National and Pakistan Refinery, do not have any OMC at present.

 

Previously PSO used to get preference in buying oil from the refineries but due to decreasing cash flows many refineries are now switching over to SPL. The main demand driver for PSO now remains its huge market demand – therefore the refineries have no option but to sell to PSO. On the other hand, the creation of a new OMC can only be bad for PSO and SPL since it will have a negative impact on their sales and profitability. Already, we have seen the 4.5 million tonne Pak-Arab refinery getting formal permission to set up its oil marketing company. This will reduce PSO ‘s sales in the nearby area when the refinery comes online in September 2000.

 

5. Oil pipeline projects are exempt from custom duty, sales tax, and other surcharges on equipment, machinery and materials.
6. Accelerated depreciation allowance @50% of the capital investment in the first year to improve the project’s cash flow.

 

In the Petroleum Policy, the GoP has also allowed generous capital allowances for oil pipeline projects along with exemption from all sorts of import tariffs. This is done so as to encourage all the OMCs to invest in better oil transportation systems – pipelines are the best means of oil transportation to upcountry destinations (detailed later on). When the oil marketing sector deregulates, the winner will not be that company which has the largest market share or the best management team. Rather it will be that company, which has the facility to serve the customers – using better and more efficient ways to transport oil so as to reduce costs, improve service and increase profits. PSO had entered into a Joint Venture (Asia Pipelines Ltd.) to lay down the White Oil Pipeline to serve PARCO refinery but due to the company’s (APL) inability to secure financial close, this contract was scrapped and later awarded to PARCO. SPL had initially lost out on the contract. Thus both SPL and PSO are encouraged to find better financial partners to take advantage of this generous offer by the GoP.

 

7. No GoP permission for setting up petrol pumps by OMCs.

 

8. Anti-adulteration law to be enforced for strict quality control and enforcement.

 

The anti-adulteration law has great ramifications for PSO especially. SPL already has a good internal quality control system – they also have ISO 9002 certification but PSO has no such thing. Although PSO has been emphasising more on quality lately, the fact still remains that adulteration is more common problem at PSO outlets. This law will only serve to increase costs for PSO – if any non-compliance case is published; it can also tarnish its reputation.

FEATURES OF THE OIL MARKETING SECTOR

 

Pure Retailing Firms

The Oil Marketing Industry, in Pakistan functions in a pure retailing manner and hence the respective companies are not mostly involved in any upstream activities. However there are certain projects that are being undertaken by these companies which involve the upstream activities. SPL has signed a contract with the GoP for oil exploration while PSO is in negotiations with Hyundai involving construction of a refinery at Badin (this has been delayed indefinitely on account of GoP’s inability to guarantee Hyundai a 25% USD return on the refinery project).

 

Industry Structure

The industry is oligopolistic – there are only a few major companies which cater to all the oil and lubricant needs of the country. These 3 companies are Pakistan State Oil Ltd. (PSO), Shell Pakistan Ltd. (SPL) and Caltex Pakistan Ltd. Then there are a few companies which are only involved in the lubricants sector – Mobil Askari and Total Atlas being more prominent than others.

 

 

PRICING

The oil marketing industry suffers from government price regulations – prices of all types of fuel oil are regulated and set by the GoP except the lubricants. The regulated prices also mean that these prices are hedged against PKR devaluation. If there is any major PKR devaluation, then the oil prices are also adjusted accordingly.

 

In 1996, the government started to index these prices with the petroleum prices in the international market. Under this formula, the domestic prices were linked to a weighted average of internationally quoted prices. Whenever the deviation in the international and local purchase prices was more than 3%, the GoP used to revise the petrol prices (upwards!) and Furnace oil (FO) and HSD rose 123% and 38% in 1996[21]. On the other hand, there was never any downward revision in the prices, even now when in April 1999 the oil prices had sunk to below $10 per barrel of the North Sea Brent. The differences in the international and local prices meant that the GoP was able to collect huge amounts of development surcharges to bridge its budgetary deficits.

 

The various components of the retail sales price is as shown below.

 

(1)  Ex-refinery/import price	Procurement prices set at par with imported POL products. Fluctuates with changes in the X-rate.                                                                      Development surcharge
PLUS
(2)  Development Surcharge	Fixed in Rs. terms and paid to the GoP
PLUS
(3)  Excise duty/import duty	Fixed in Rs. terms and paid to the GoP
PLUS
(4)  Inland Freight Equalisation Margin	Transportation costs reimbursed by the GoP to the OMCs.
PLUS
(5)  Fixed Distributor Margin	Return to OMCs as a % age of the retail sales price. Varies for different products.
PLUS
(6)  Dealer Margin	Commission as % of the retail sales price and transferred to the retail outlets owners.

 

The importance of the development surcharge component in the retail prices of POL has already been mentioned above. Another important price driver is the Inland Freight Equalization Margin (IFEM). The main aim of this is to keep the prices of POL products same in all parts of the company. Since the selling expenses are borne by the OMCs themselves, such as transportation to the required destination etc., the OMCs can charge a higher price in the remote locations of the country citing higher transport costs. Since the GoP reimburses these costs to the OMCs, the prices of POL remain same throughout the country.

 

The IFEM suffers from a number of disadvantages and the OMCs are all clamouring for its removal. One is that the GoP often delays payments – which translates into working capital difficulties for the OMCs. If abolished, the OMCs stand to gain as they can charge higher in other areas, make more profit and have better liquidity to invest in better transport infrastructure. Another disadvantage of the IFEM is that the present system is subsidising inefficient transportation system. POL products are dumped nearby while IFEM is claimed for long distance delivery.

 

SPL has proposed total abolishment of the IFEM while PSO has proposed to the GoP that it should subsidise transport to the oil depots only and the remaining part of the transport costs will be borne by the consumers. Also as a step closure to the deregulation of the oil-marketing sector, the GoP will consider the abolishment of the IFEM soon. One particular thing to note is that if removed, PSO should stand to gain more than SPL due to their higher investment in storage and transport facilities throughout the country.

 

DEMAND OF POL PRODUCTS

 

 

RED: WHITE OILS (LHS)

BLUE:            BLACK OILS (LHS)

—-:      TOTAL POL DEMAND (RHS0

 

 

Energy Demands

 

Growing energy demands due to increased thermal power generation and greater electrification of the country, annual 2% population growth rate, GDP growth between 3-6% all combine to fuel demand for POL products in the range of a CAGR of 6-9%. The attached graph[22] clearly shows that the country’s oil demand is growing at 8% annually and will reach 31.7m tonnes in 2005 compared to 20m tonnes currently.

 

Transportation Demand

 

Both white oil and black oil are forecasted to rise by more than 6-7% annually. White oil products are mainly HSD, Kerosene and Mogas. Amongst white oil, the highest growth is forecasted to be in the HSD sector due to higher transportation demands of the country – HSD is forecasted to grow at 7% while Mogas is forecasted to have substantial growth of around 4%. Kerosene and JP-1 are not forecasted for aggressive growth due to declining market for them. Approximately 200,000 vehicles are added each year with the largest share being those of the heavy transport machines. These lead to higher HSD demand.

 

Industrial Demand

 

Black oil consists of bulky commodity products such as furnace oil and light diesel oil. FO will have aggressive growth initially (around 10%) due to increased demand from the thermal power plants. This will subside later on for a CAGR of 5-6%. Also there are various industries which need some sort of fuel as input. Growth in the economy, higher industrial development, and output of the cement, PSF, chemicals etc sector will lead to a higher demand for fuel oils.

 

Lubricants

 

The lubricants industry – the deregulated POL products – are expected to grow at 6% during 2000-2005. With margins on these products running at 15-20%, this sector continues to remain attractive to the foreign investors and promises increased profitability for the OMCs if they can market their products effectively. New entrants in this market are Mobil and Total – both having reputable local partners. According to the Oil Companies Advisory Commission (OCAC), the size of the lubricant market is around 250,000 tonnes out of which only 170,000 tonnes are official. OMCs need to adopt aggressive marketing and build customer loyalty if they are to be successful in this sector.

 

 

SUPPLY

The growing demand of oil is first met through local production and all that the refineries can churn out. Extra demand is imported in the shape of the final product – PSO and Kuwait Petroleum handling all the import duties of the GoP. Only a small amount of lubricants are imported by the lube companies themselves.

 

Pakistan relies heavily on refined and crude oil imports to finance its growing oil needs. The present oil reserves are in danger of finishing out in the next 10-12 years unless substantial new reserves are discovered. This problem is further exacerbated due to the low refining capacity of the country. We currently have only 8m tonnes of local refining capacity out of total needs of 20m tonnes – only 40%. The 60% imports put great pressure on the FX position of Pakistan and in the current year, POL imports are scheduled to cross the $2 billion barrier.

 

The Petroleum Policy of 1997 gave numerous incentives to investors to set up refineries and one major refinery that it being set up is the Pak-Arab refinery at Multan. However even after this, the refined oil deficit is set to remain – necessitating the need for additional refineries. Other refinery that might see financial close is the Pak-Iran Refinery which will be located at Khalifa Point, Baluchistan. There were a number of other refineries that were planned – PSO-Hyundai refinery with a capacity of 4.8mn tons, Kuwait Petroleum’s 4.5mn tons and Schon group’s 1.5mn tons; have all been scrapped due to difficulties in financial close.

 

To meet the shortfall in supply, we have to resort to importing crude petroleum as well as refined POL products. Local production is only 59000 bpd – 18% of our total requirement of 350,000 bpd[23] leaving us with net imports of 290,000 bpd. The relevant import data for the latest periods are shown below.

 

In July-March 98-99 our petroleum imports totalled $1.1 billion while it is scheduled to exceed $2 billion this year on account of higher international oil prices. During the period July-January 1999-2000, we have imported 6,558,783 tonnes of petroleum products at a cost of $1 billion[24]. The percentage change in quantity is 14.40 percent while it is 89.08 percent in value – reflecting the higher international oil prices. The import of 2,582,001 tonnes of petroleum crude during this period cost $ 436.101 million as against the 2,686,283 metric tonnes valued at $ 241.612 million during the corresponding period last year. The import decreased by 3.88 percent during this period but its value increased by 80.50 percent.

 

FUNCTIONING

The crude oil is either extracted in the country or imported by the government of Pakistan. It is then sent to the refineries (here to National Refinery, Attock Refinery and Pakistan Refinery and also to refineries abroad) which refine the crude oil. The refined oil is then transported to all the oil marketing companies (OMCs) – namely PSO, Shell, and Caltex. Mobil and Total also buy the base oils from either these refineries or they can have it imported from anywhere else in the world.

 

 

FIGURE 3 : OIL INDUSTRY FLOW CHART

Transportation of oil from its source to the OMCs is through pipelines or through other means such as independent contractors by roads and railways. Most of the time it is through pipelines that run from the refinery to the storage terminals of the respective oil marketing companies.

 

Once stored in the terminals of the oil marketing companies, it is then the property of the OMC, and is recorded as a purchase. The OMC then retails and markets the oil and distributes it through different channels such as pipelines, tankers, rail bogies for sale to the ultimate customers.

 

 

PRODUCT BASE AND CUSTOMERS

The main products of these OMCs are High Speed Diesel (HSD), Furnace Oil (FO), Motor Gasoline (Mogas), Jet Fuel, Kerosene, Light Diesel Oil (LDO), High Octane Blending Compound (HOBC) Lubricants and Greases.

 

Major customers are Industries, Power Plants, Armed Forces, Railways, Airlines, Retail Outlets, Transportation, Marine and the Government.

 

HSD, Mogas and HOBC are primarily used for transportation purposes. FO, LDO, Kerosene are mainly used in industries such as paint, PSF etc with Furnace Oil being a major component of the thermal power stations. Jet Fuel, which is highly purified kerosene, is supplied to the airlines while the lubricants and the greases are for automobiles, industrial machine parts and for many other purposes.

 

Regulated environment

The oil marketing sector is heavily regulated. Government regulations cover various facets of the industry such as importing oil to the Karachi port, upcountry transportation, location of storage depots, and the retail prices of the POL products.

 

Petroleum products can be divided into 2 categories: energy products and non-energy products. Energy products consist of products such as furnace oil, Light Diesel Oil (LDO), HSD, Mogas, JP-1 and kerosene – the GoP regulates these prices. Similarly, the GoP also sets the distribution margins of these OMCs – currently they are on average 2%[25] of the retail prices. These margins were last revised in February 1995 and all subsequent Petroleum Policies have always stated the GoP’s intention to gradually revise them to 5%[26] but this has not seen the light of the day so far. Non-energy products are lubricants and other petrochemicals which are not regulated and the margin on these products currently run around 15-20%[27].

 

Margin Revision

 

In the latest Petroleum Policy 1997, the GoP has continued to stress on margin revision provided that these companies invest in infrastructure development. While PSO and SPL have been very active in various capex projects, there is still no sign of these promised margin revisions. In FY97, the GoP taxed Rs. 19.5bn[28] from development surcharge on these POL products – almost equal to 8% of the total revenue receipts. Since any sort of margin revision would reduce this development surcharge (assuming no further price increases), it looks highly unlikely that the GoP would consider any margin revision. At most we might just see a 50 basis point revision in FY2000 or FY20001 maximum. This would reduce the surcharge by Rs. 1.5bn, which the GoP may be able to collect from additional tax revenues.

INFRASTRUCTURE PLANS

 

Port Handling Capacity

 

There are 4 oil jetties here – three at Kemari (OP-1, OP-4, OP-5) and one at Port Qasim (FOTCO). FOTCO suffers from dredging while all other jetties are also not operating at their full capacity. Keeping in mind the increase in oil demand, there is a need to increase the jetties’ capacity/improve them.

 

 

Storage Capacity

 

The present oil storage capacity is only 14-15 ‘days cover’ and this will be further reduced in the future as oil demand continues to rise. At present PSO and SPL are both investing funds into expanding storage capacity. To come up to the GoP’s target of 30-40 ‘days cover’; these OMCs have to invest more than $100 million.

 

 

White Oil Pipeline

 

There is an existing pipeline (Karachi – Mehmoodkot) which transports finished products to Punjab areas. When the PARCO refinery comes on line, this pipeline will be used to transport crude to the refinery. At the same time, another pipeline will be laid alongside the original one to transport white oil. This contract had initially been awarded to a consortium led by Asia Pipeline Ltd (APL) – a subsidiary of PSO. Due to inability of reaching financial close, this contract has now been scrapped and given to PARCO. The estimated cost of this pipeline is $700 million.

 

Upcountry movement of POL products

Currently, the most popular ways of transporting POL to the upcountry destination are Rail, Road and Pipelines.

 

 

Mode of transportation	Million Tonnes	%	Value in Rs m	%
Rail	2.0	11%	1726	15%
Road	8.5	47%	6581	55%
Pipelines	7.5	42%	3625	30%
Total	18.0	100%	11932	100%

      Table 2 :- Movement of POL Products

 

 

The benefits of using pipelines to transport oil upcountry are enormous – safety, congestion free environment, speed of transportation etc. However the costs of maintaining and laying down a pipeline are also very high – PSO is better than SPL in this regard as they already co-own a pipeline as well as the new white oil pipeline through a subsidiary. Secondly, pipelines are also the most economical way of oil transport. They account for 47% of volume and 30% of the value. This makes them more economical than the railways – which are already unreliable.

 

 

EXPOSURE TO RISKS

Every industry is exposed to certain risks.  The challenge that the management faces is to minimise these risks so as to increase profits for the future.  Certain risks and issues that the Pakistani Oil Market/industry faces are as follows:

 

CONVERSION INTO GAS POWERED INDUSTRIES

 

There are certain power plants – HUBCO, KESC, KAPCO etc, as well as certain industries such as cement, which are capable of using gas as well as FO. With the rise in import bills and high cost of FO in the country and the IPP-Tariff war, the pressure is on the GoP to let the IPPs convert to Natural Gas. If this were allowed, then substantial FX and internal cost savings could be achieved which could be passed onto the consumer. This will however reduce overall industry demand and cause industrial profitability to fall.

 

PSO will be most affected by this since they are concentrated totally in the power fuel supply sector and mostly in the industries sector while SPL is somewhat immune to these changes. If this were to pass through immediately, the next year’s earnings could be substantially low and this might reduce the capex that these firms – especially PSO might have planned.

 

PUBLICS SECTOR TRIANGULAR DEBT

 

WAPDA and KESC, being government institutions, the OMCs could not refuse credit. But since PSO got preferential treatment, SPL stopped or reduced governmental dealing on account of this problem. PSO however continued on with this. Result is that PSO now owns huge debts to the refineries while the KESC and WAPDA owe similar huge amounts to PSO. This creates liquidity problems for all three companies. PSO suffered more on this that SPL did.

 

As WAPDA and KESC are restructured, the OMCs have a greater chance of getting their money back. Already KESC has launched Rs. 11bn worth of TFCs so as to repay all the credit purchases. PSO is more likely to benefit from this sector since they are more exposed to it while SPL’s dealings with the state run companies is at a minimum.

 

REGULATED ENVIRONMENT

 

Further on the oil marketing sector is also highly regulated. Prices and distribution margins are all set. While the GoP has promised to raise the margin if the OMCs invest in infrastructure, this is not happening that  while OMCs are putting in millions to improve the petroleum related infrastructure of the country. Already SPL and Caltex have been indirectly restrained form carrying out expansion and development plans and PSO is highly favoured. The best example is of the FSAs. The GoP allowed the IPPs to buy FO from any OMCs but at the same time guaranteed PSO’s commitment to supply FO. Thus while PSO is allowed to catch up, others are restrained from getting too much market share.

Recommendations

• Improve performance in the oil marketing sector to counter the threat of substitute products like Natural Gas

 

• Improve efficiency and service of the sector

 

• Develop appropriate marketing mix strategies

 

• Selling the brand name through effective advertisements and media

 

• Stop making any concessional payments to Public Sector ORGANIZATIONS like K.E.S.C and W.A.P.D.A.

 

• Shorten the collection period to reduce the cash flow problem.

 

• Deregulate the Environment to encourage competition

 

• Non-price Competition

 

 

 

[2] Interview at Shell

[3] Shell 99 Annual Report

[4] Shell 99 Annual Report

[5] IRS Report #783 Jan 1999

[6] Economic Survey 98-99

[7] Economic Survey 98-99

[8] Economic Survey 98-99

[9] Economic Survey 98-99

[10] Economic Survey 98-99

[11] Economic Survey 98-99

[12] BOA report

[13] Business Recorder 13/2/00

[14] Interview at Caltex

[15] PAGE 11 Sep 99

[16] KASB report on PSO

[17] Shell 1999 Annual Report

[18] KASB report on PSO

[19] KASB report on PSO

[20] SPL 1999 annual report

[21] http://wavenet.cyber.net.pk

[22] IRS 793 April 1999

[23] Economic Survey 98-99

[24] Business Recorder 13/2/00

[25] KASB Report on PSO

[26] HSBC forecasts

[27] HSBC reports

[28] Economic Survey 98-99

 

 

Quality Reports on Pakistan’s Economy and Business Sectors for Students

• Textile Industry of Pakistan – A Research Report

• Cement Industry of Pakistan – An Academic Report

• Pakistani Automobile Industry – In-depth Analysis

• Sugar Industry of Pakistan – An Academic Report

• Pharmaceutical Industry of Pakistan: Financial Analysis

• Oil Industry in Pakistan: Academic Report

• Banking Sector in Pakistan: Academic Study

• Pakistani Leather Industry – A Marketing Report

• Pakistan Steel Mill: Analysis