Sectoral policies: start with deregulation – Opinion

The government is in the process of developing policies for certain sectors such as refineries and automobiles. Having well-defined policies in any sector is the right approach to give the right signal to investors, enabling the government to seek investment in the desired areas. However, policy formulation becomes weak in Pakistan, as the modus operandi is extremely ad-hoc. Discussions take place with industry players who present their wishlist, which is then slightly edited. And get out of politics.

This is not the right approach. The government’s intentions may be well placed, but execution is weak. There is a need to engage independent consultants to assess sector dynamics and prescribe policy measures. In many cases, bureaucracy and companies fail to even come up with a decent ToR. Yet they formulate policies for billions of dollars in investment. If a policy is done the right way, it pays dividends. For example, during the Musharraf era, the government hired international consultants and proposed a framework to deregulate the telecommunications sector, which led to a revolution in the industry.

Obviously, industry players have specific interests, so the government should not rely solely on them. Experts also come and go in the form of SAPM and advisers to PM. And in many cases, they have conflicts of interest. The media debate is usually superficial, but the media have an impact on policy makers. Ministers are influenced by the media and hearsay from their friends in the industry. There is no consistent approach.

For example, in auto policy, the government supports local assembly by incentivizing Completely Knocked Down (CKD) imports. But the Semi Knocked Down (SKD) import is not incentivized at all. Both cases have their own advantages and disadvantages. In case of CKD, auto assemblers / manufacturers build assembly lines, press shops, paint shops, etc., and all the machines are imported and most of the raw materials are imported, and the car is produced specifically for home use. In the case of SKD, the assembler imports the body from the hull and can assemble even without paint and press shops. This approach can lead Pakistan to export automobiles by adding some value.

The role of the government should not favor a specific model but favor the local production of vehicles. It should have rules and regulations on vehicle specifications and safety, but not the method of assembly. Leave the decision to adopt a certain method to the investors. However, CKD assembly is the norm among existing players, they present themselves as stakeholders in consultations with the government, and the SKD option is never seriously considered.

The other hot sector under discussion lately is the oil refinery. A policy document was prepared by Nadeem Baber (when he was SAPM Petroleum) in consultation with existing industry players. The policy contemplates billions of dollars of investment and incentives are offered (to be charged to consumers) based on some type of expansion. It is written in the policy that no new hydraulic skimming refineries are allowed and that the refinery must be in deep conversion. This is the wrong approach. The government must define certain grades and specifications of petroleum products – for gasoline, diesel and others, which must be produced locally. Whatever equipment and method the investor deploys, it is his (more) choice.

For example, hydraulic skimming is ideal for processing light crude, while deep conversion is more suitable for heavy crude. Light crude is expensive, but the hydraulic skimmer plant is cheaper. On the other hand, heavy crude is cheap, but deep converting technology is expensive. It is a question of economy. In one case the cost of (fixed) capital is high while in the other the (marginal) cost of raw materials is high. Let the investor make the decision. By not allowing hydraulic skimming, the government could lose the potential of light crude and condensate produced at KP. One option could be to have a small (hydro-skimming) refinery on site and for further processing, the products can be sent to a larger refinery. Let the investors do the math.

Some people claim that heating oil (furnace oil) is produced using the old methodology and that its demand is declining. Yes that is correct. But it is a headache for investors to find ways to sell OFs. Back in those days, when refineries were first built in Pakistan, FO was a hot cake and hydro-skimming was fine for everyone because the FO produced was residual. Now, after IMO 2020, international demand has dropped and local demand is also declining with the commissioning of RLNG and coal-fired power plants. If a refinery in Pakistan – with or without expansion – does not process the further processing of the PO into other products, it will die. Let the investor handle the business issue.

Then there were arguments about whether a certain refinery imports old factories and whether the government should offer incentives to bring in old factories. Again, it is not for the government to decide what type of equipment a refinery can use. The government must define control mechanisms and product specifications. If someone uses an old refinery to do it, let them do it.

The government must realize that the capital expenditure for any new refinery is too high. There is talk of having a large refinery in Pakistan by foreign investors for two decades – but no real development has materialized. The return on investment could reach 20 to 25 years to break even. As the world moves towards electric vehicles and hydrogen vehicles, the demand for road fuel – gasoline and diesel – could drop. Let the investor decide the future. The government should be happy if environmental and other standards are met.

The other question is on what basis the government makes Euro-V fuel the only option. Have studies been done on the type of vehicles on the road and the type of fuel needed to control air quality? What types of pollutants to control and how? What are the vehicle exhaust specifications and, based on them, what type of fuel is environmentally and economically efficient? Automotive specifications and fuel options for refineries go hand in hand. They cannot divorce. And simple copy and paste of European standards may not be suitable.

Almost half of the country’s oil consumption is for motorcycles. Does spending the jackpot on Euro-V for these basic bikes make sense? In Europe, there are specifications for the exhaust gases and a high sulfur content can damage the catalysts in the exhaust gases, which kills other pollutants. Otherwise, the sulfur dioxide itself remains high in the air, not causing respiratory problems. Then the country imports Euro-V and local refineries use Euro-II standards. The question is how effective Euro-V will be if Euro-II goes through the same pipelines and tankers.

You should not copy and paste without understanding the realities on the ground. This is why before finalizing the refining policy, certain international consultants should be hired to propose specifications and deadlines. Then, on the basis of these, incentive structures should be given.

The government must think about deregulating the industry. If the government does not do any studies, it must deregulate the industry and let the refineries compete with the imported product. The government only sets specifications and deadlines on products. He must think about the coverage of import duties for refineries – proposed at 10% for gasoline and diesel and let the sector take its course. The case of the automobile is similar when there is customs protection for local assembly from imported units. Do the same for the refineries.

The government must work to end regulated oil prices. It should put an end to the IFEM (internal freight equalization margin). Let the refineries openly compete with each other. As was the case with telecommunications and banking, deregulation in the oil refining and marketing sectors would most likely bring efficiency gains and prices could fall. However, the government would lose control over prices. And by keeping control, policymaking becomes complex and some fear that market players will exploit consumers. Government needs to learn that if markets are efficient, government and consumers would be happy to see the industry deregulated.

Copyright Business Recorder, 2021

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