Energy Reforms To Support Fiscal Accounts
BMI View: The Pakistani government's efforts to reform the country's energy sector, which include reducing subsidies, improving concessional and production sharing contracts, and the upcoming partial privatisation of two of its national oil companies, should provide support to the fiscal accounts. In addition to direct savings via reduced subsidies, and the revenue boost provided by the partial asset sales, greater energy production would provide a major boost to the manufacturing sector, which would in turn allow tax revenues to rise from their current low base.
We have previously highlighted the large role that the mismanagement of Pakistan's energy sectors has played in keeping the country's fiscal accounts deeply in the red. Not only do subsidies to consumers take up a large chunk of government expenditure, but the ongoing energy crisis undermines economic activity and thus weighs on tax revenues across the entire economy. The government has taken steps to increase electricity tariffs to large consumers (above 200 KWh per month) in line with the IMF programme, who expects this, together with the settling of circular debt in the power industry to save the government as much as 0.75% of GDP per year.
We are also seeing signs that reforms to the upstream oil and gas industry could have a positive impact on Pakistan's economy and fiscal accounts over the coming years. Indeed, Pakistan has plans to sell 5-10% stakes in two of its national oil companies (NOC), Oil and Gas Development Company (OGDC) and Pakistan Petroleum Ltd. (PPL), according to the country's Privatisation Commission. A financial adviser will be appointed to help manage the divestment, with bids for the role to be submitted by April 16 2014. Currently, the Pakistani government owns an 85% stake in OGDC and 78% stake in PPL; according to the commission, divestments will take around three months to complete and is expected to raise around US$1bn. Shares in PPL will be sold exclusively on the domestic market, whilst stakes in OGDC will be marketed internationally.
|Gradual Deficit Narrowing Ahead|
|Pakistan - Fiscal Balance, % of GDP|
We expect this privatisation drive to have a positive impact on the oil and gas industry. For several years Pakistan has been looking to boost investment in the country's upstream sector. With natural gas the primary source of energy, Pakistan is facing rising domestic energy shortages as consumption rises amidst falling gas production. We calculate that total gas consumption reached 39.9bn cubic metres (bcm) in 2013, capped on par with total gas production. However, we believe that unrestrained gas demand may have run as high as 80bcm. With the Iran-Pakistan pipeline now in jeopardy, Pakistan will be under increased pressure to boost domestic production.
In 2012, a new hydrocarbons law was passed, offering companies improved concessional and production sharing contracts. The government has also revised its gas pricing policy, increasing the wellhead price for gas from US$2.50-3.20 per million British thermal units (/mnBtu) to US$6-6.60/mnBtu and is offering higher potential returns to investors. Results are beginning to filter through, with an uptick in exploration and production activities returning a number of discoveries in recent months, notably Jura Energy's finds in the Guddu Block and at Badin IV South. While discoveries have tended to be modest, they are nevertheless important in the light of the tightening supply/demand dynamics of Pakistan's gas sector.
We expect the sale of OGDC stakes to attract interest both domestically and internationally. The company has a reasonable asset base, boasting the largest portfolio of recoverable oil and gas resources in Pakistan; ONGC contributes 28% of the country's total gas production and 52% of its total oil production. PPL has a similarly strong foothold in the market, producing around 20% of the country's gas and 15% of its oil. Both companies have been pushing to expand their reserves bases and boost production levels and we believe that greater private sector involvement will help accelerate this process, offering a much-needed capital injection. We see this as being particularly important as Pakistan's NOCs look to develop the country's unconventional and deepwater resources.
Given the importance of both companies to Pakistan's oil and gas sector, we also see this contributing to the broader rationalisation of the country's upstream industry. We believe a wider role for the private sector will help support improved investor sentiment, which will be vital as Pakistan looks to draw investment from an increasing number of international firms, as with the country's ongoing onshore licensing round.
Significant Obstacles Remain
Privatisation policies have often proved difficult to implement, meeting heavy resistance from trade unionists and Pakistan's political opposition. Equally, despite efforts at reform, widespread corruption and a weak rule of law continues to plague the country's operating environment. The oil and gas industry also suffers from the critical lack of infrastructure in Pakistan. In addition to the myriad challenges that remain above-ground, Pakistan also faces the constraints of limited below-ground potential, given its poor reserves base and the small scale of recent discoveries. We see the combination of these factors continuing to limit interest from larger international oil companies. Nonetheless, any progress made in boosting energy production and reducing the need for blackouts that cripple the manufacturing sector would provide a very welcome boost to the country's economic outlook and fiscal position. In addition, privatisation proceeds will help to support fiscal revenues in the near term. We forecast the fiscal deficit to decline gradually from 6.8% of GDP in FY2013/14, to 5.8% of GDP by FY2017/18.