January 14, 2020 (MLN): Smuggling of Iranian oil has been a significant threat to market players, government and end-consumers. Pakistan is losing around Rs200 billion in tax revenue to fuel fraud every year.
At present price levels, this translates to about 4mn tons of combined volumes of diesel (HSD) and petrol (MS), which is nearly 25% of the formal combined sales of 15mn tons in CY20.
A report by the World Bank on “Petroleum Taxes” said that taxes on petroleum products are a critical source of government revenue. The report states: “The reason (why downstream taxation of petroleum products are important to low-income countries) is that taxing fuel is one of the easiest ways to get revenue: collecting fuel taxes is relatively straightforward, and the consumption of fuels as a group is relatively price-inelastic and income elastic, ensuring buoyant revenue as income rises and tax rates are increased.”
The countries that earn a significant share of their total revenue from fuel taxes, fuel smuggling severely restricts the efficacy of government services that support all strata in a society.
To curb the cross-border fuel smuggling, the tax authority Federal Board of Revenue (FBR) has reportedly initiated a crackdown as per directions of Prime Minister Imran Khan.
According to the research report by Intermarket Securities, the smuggled volumes of HSD is far greater than that of MS. Instructively, during June 2020 when the Iranian border was still closed, local HSD and MS sales rose by 70% and 30% YoY, respectively. Granted, that the jump in sales was partly driven by the pent-up demand phenomenon post lockdown during April-May.
Fuel smuggling is damaging the legitimate petroleum industry and the government at a time when the economy is in a recovering phase. The research highlighted that the smuggled volumes affected OMCs in the following two ways:
- Lost sales to dealers/pumps which could otherwise avail cheaper smuggled fuel. This is more likely in rural areas. it is pertinent to note that taxes and levies on retail fuels comprise 40% of pump prices, while normal dealer margins are 4% of the price.
- Trucks and other heavy vehicles can fill up tanks (often expanded up to 1,000 liters) at undocumented outlets near the border or around the country. As per research, this is a more prevalent practice among the two.
If the crackdown is able to materially reduce smuggled volumes into Pakistan and lead to the closure of illegal retail stores or pumps, this will have a significant positive impact on the OMC sector. Given that the matter has reportedly caught the Prime Minister’s attention, the government should be able to achieve this to a great extent. Accordingly, total petroleum sales may potentially jump by up to 20% from present levels, without any additional trigger from the economy, the report assessed.
For retailers such as PSO, SHELL, Total-Parco, APL, and possibly Hascol which have a cumulative market share of 75%, the crackdown against the sale of smuggled oil would be great news as they stand to benefit the most. While smaller OMCs sell much of the smuggled fuel. This is positive for the overall sector,
PSO – being the largest OMC with over 3,500 pumps and deepest countrywide penetration – may benefit more than the other incumbents, in terms of market share. This is probably already happening, as during 1HFY21, industry HSD sales rose by 12% YoY and PSO’s share rose by 3ppt YoY to 48%. The research highlighted that normalizing sales in the rural areas will also benefit PSO more as the multinational OMCs are centered in the cities.
For the oil refineries in Pakistan, however, the upside in sales will be limited. Assuming they operate near full capacity (given adequate and timely off-take of their furnace oil production), the additional volumes sold by the OMCs will have to be catered by imports, the research added.
Depending on the complexity of the crackdown to curb the fuel fraud, even if the government is able to draw PKR100bn of additional revenues from the Petroleum sector by halving the volumes of smuggled fuel; that amounts to about 0.25% of GDP. In the backdrop of rising domestic demand and also international prices, the actual impact is likely to be greater than that, the report estimated. This financial benefit to the government will also lift conviction in an ultimate resolution of the issue, the report underscored.
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