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Decline in oil prices: Can Pakistan reduce power tariff to help its industries?

Global oil prices plummeted to a historic low level meanwhile Pakistan produces its electricity from furnace oil. It should mean that Pakistan's industries can produce cheaper goods. This article reveals the science behind oil prices.

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Global lockdowns, which have been in place in varying degrees, but mostly quite deep and extended given the expected prolonged nature of Covid-19 onslaught, have resulted in drastic reductions in oil demand, which currently has gone down as deep as 30 million barrels a day.

A long and painful deliberative process to cut the global supply of oil by OPEC+ group of major oil exporting countries, each vying for greater oil revenues and lesser of proportion of cutting down supplies, could only manage to reach consensus on cutting around 9.7 million barrels a day of oil supplies. By the last week of March, however, the consumption of crude had dropped by between 15 million and 20 million barrels a day from the normal level of 100 million barrels a day.

Hence, a lack of needed response in oil supply cuts, resulted this week first for the WTI (West Texas Intermediate) futures for May went into negative territory for the first time in history, selling at negative $40 a barrel, indicating the most drop intraday on Monday in WTI since 1982, according to Bloomberg – the last time there was a global oil crisis. The unprecedented crash in WTI, meant that for the same reasons, the Brent crude oil dropped to below $20 a barrel for the first time in 18 years.

Read more: Oil price war comes to an end; Implications on Pakistan

According to Wall Street Journal, ‘U.S. crude-oil futures for delivery in June rose 19% to $13.78 a barrel, extending a series of chaotic moves. The most heavily traded U.S. crude benchmark on Tuesday collapsed to a 21-year low, with supply overwhelming demand and storage in many parts of the world full.

On Monday, a U.S. crude futures contract turned negative for the first time ever, effectively meaning sellers were paying buyers to take away oil due to a lack of storage. The contract that turned negative early in the week expired in positive territory on Tuesday. Brent crude futures, the global benchmark for oil markets, climbed 5.4% to $20.37 a barrel on Wednesday but also remained near a multidecade low.’

There is just very little space to store oil, and that is the main reason behind the crash in both WTI and Brent. And the situation of some form of lockdown is likely to continue as even some of the optimistic scenarios about Covid-19 are indicating that it is still yet to peak, and that it may come again at least once this winter, and a vaccine could at least take another 12-18 months. This means oil demand is going to show weak signs for many months.

For countries like Pakistan, where a significant portion of import bills are based on oil imports, and where a big hit on export earnings in the wake of the pandemic

Storage tanks and even floating storage for oil has almost reached full capacity. In fact, the built up in oil storage has already increased a lot more than last three years. According to ‘Orbital Insight’, a company that according to Bloomberg ‘uses optical and radar satellite observations to estimate crude in floating roof tanks, which it estimates covers approximately 70% of total on-land storage’, pointed out that on April 19, 2020 crude that is placed in oil tanks had already surged to a three year unprecedented level – a by a big margin that is – of 3.2 billion barrels; when at the same time it stood at 3 billion barrels in 2019, and 2.9 billion barrels each in 2018 and 2017, respectively.

This means that the current crash of prices will continue for at least some months. According to Amrita Sen, who works at Energy Aspects Ltd. as chief oil analyst, ‘We’ve calling for $10 Brent for a while, and we’ve absolutely looked at single digit prices.’ At the same time, it appears that even if OPEC+ group continues to cut supplies in a big way, which it has to anyways – drilling is already halting and wells are being shut in US, which is the biggest producer of oil – since storage is running out a lot faster than very weak expected demand built-up, at least in the short terms and probably which will weaken cyclically for some time at the back of probable Covid-19 rounds and with it lockdowns, supplies built-up will not allow prices to rises in any quick way in the coming months.

Read more: Yes, the world economy is collapsing!

While this means revenue losses for oil-exporting countries, it brings a much needed air of ease in terms of oil-related balance of payments pressures for most of Asia – especially the developing countries here – except for Malaysia, which is the only net exporter of oil, while the rest are net importers of oil. For countries like Pakistan, where a significant portion of import bills are based on oil imports, and where a big hit on export earnings in the wake of the pandemic, the falling oil prices should allow it manage its balance of payments in a better way in the coming months.

At the same time, Pakistan produces a significant amount of electricity based on furnace oil. Now falling oil prices and the same trend in the coming months overall, should mean that electricity tariffs should actually fall in a significant way for both household and industrial consumers; with benefit both in terms of safeguarding depleting household incomes, and in turn aggregate demand, in the times of lockdowns and to help boost aggregate supply and bringing much needed competitiveness to exports.

The Dated Brent benchmark, a global reference almost two-thirds of the world’s physical flows, plunged to $13.24 a barrel on Tuesday, the lowest since 1999, according to price reporting service S&P Global Platts

What the government should not do is try to keep the price of oil relatively high, and not transfer the pass-through of oil prices internationally to domestic consumers, mainly to earn revenues for the treasury. This may very well prove to be a wrong strategy, because power sector is stuck in an unprecedented circular debt crisis, and any revenues made by the government will in a significant way go in keeping the power sector afloat through heavy bailout, with no benefit to the end-users of electricity, and at the same time this will not help bring inflation down or help boost exports or foreign reserves, already hurting from falling exports, dropping remittances, and lukewarm debt moratorium response from the international community up till now.

Rather the cost of production of electricity should be allowed to go down at the back of much reduced oil prices domestically, which will remain possible for many months, especially if proper strategy is adopted to lock in better futures for Bent. In this regard, the related government authorities should think about engaging international insurance companies to obtain future Brent prices, where a floor is kept on prices just above the single digit, and a ceiling of not more than $20 a barrel, at least in the short run. Our policy makers should think of ways to create greater storage capacity, to cash-in on this unprecedented fall in oil prices.

Read more: Here’s why oil prices hit to the never ever levels

That the prices are showing declining signs going forward, could be gauged from the following insight for instance, as Bloomberg pointed out, ‘The Dated Brent benchmark, a global reference almost two-thirds of the world’s physical flows, plunged to $13.24 a barrel on Tuesday, the lowest since 1999, according to price reporting service S&P Global Platts. On Wednesday it was assessed at $14.21 a barrel, Platts said. With the price so low, key European and African crude streams including Urals and Bonny Light will now sell under $10, as they trade at a discount to the marker.’

Dr. Omer Javed is an institutional political economist, who previously worked at International Monetary Fund, and holds a Ph.D. in Economics from the University of Barcelona. He tweets at @omerjaved7. This article originally appeared at Business Recorder and has been republished with the author’s permission. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space. 

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