July 16, 2021 (MLN): Pakistan State Oil (PSO), being one of the prominent energy company of the country is presently engaged in the marketing and distribution of various POL products including Motor Gasoline (Mogas), High Speed Diesel (HSD), Furnace Oil (FO), Jet Fuel (JP-1), Kerosene, CNG, LPG, Petrochemicals and Lubricants.

The company is working diligently to fuel the energy needs of the country for more than four decades. It believes in innovation, modernization, and technological upgradation which kept the company ahead on the competitive curve.

In addition, the flourishing retail segment has also provided cushion to PSO to make the most out of it as the Oil Marketing Companies (OMC) industry witnessed 18% YoY rise in volumetric sales during FY21, with retail fuel (Mogas & HSD) sales recording an increase of 14.2% during the period. This is primarily attributable to rise in auto sales which has increased by 48.5% YoY and reinitiating of transport as overall aggregate demand in the economy surpassed the Pre-Covid levels, a research report by Insight Securities highlighted.  

HSD sales also rose by 16.7% YoY and up by 41.2% QoQ due to increased agricultural activity on account of rabi crop harvesting season from April to June and OGRA’s strict actions against smuggled diesel from Iran.

PSO being the market leader in retail fuel segment heavily benefited from these developments posting a 19.3% YoY growth in volumetric retail sales. During FY21, FO volumes also showed impressive growth of 53.2% YoY i.e, 2.9mn MT mainly due to increased demand from power plants as electricity generation from black oil rebounded 27% during the same period. Likewise, RLNG shortfall during July’21 due to closure of Engro LNG terminal allowed power producers to shift towards FO for electricity generation during the short period. FO is expected to be phased out due to cheaper alternatives and non-preference of load factor in electricity generation by power producers, the report added.

The research further revealed that FY20 witnessed the lowest OMC volumes at 16.4mn tons, 33% drop since industry peak of 2018 (24.7 mn). The decline in volumes were primarily driven by economic contraction and reduced transportation due to pandemic. After a distressed period of two and a half years coupled with high finance costs, low volumes and massive inventory losses. FY21 witnessed revival in sales volumes for the OMCs industry where total volumes rose 18% YoY while PSO total volumes climbed 23.5% during same period.

It is pertinent to mention that revival of car sales by 48.5% in FY21 due to repressed demand in FY20 and entry of new automakers encouraged by auto policy, increased LSM activity 11M, up by 14.6% and overall revival of economic activity has prompted OMC industry volumes to settle at 19.3mn MT during FY21, as compared to 18.3mn MT during FY19, Pre-covid level.

Going by the report, the economy is expected to grow at a rate of 4.8%, which would improve industry’s retail sales even further. To recall, Mogas and HSD sales are highly correlated with the overall health of the economy. Furthermore, easing travel restrictions will improve Jet Fuel offtake wherein PSO’s market share is 92%, which is expected to normalize going forward.

During FY21, the company invested in storage capacity by adding 60,000 tons to MOGAS and 50,000 tons to HSD storages. Other capex included improvements in existing storage and logistics facilities and conversion of FO depots into white oil storages. These developments have allowed PSO to carry up to 22 days of MOGAS and 30 days of HSD inventory, far adequate in terms of regulations said by OGRA of minimum of 20 days. The company also incorporated a 47.3km white oil pipeline project during 1QFY21, with total capex of approximately Rs3.1bn.

With regards to circular debt, the report underlined that company’s total receivables on 3QFY21 stood at PKR210.3bn, up by 5.3% YoY, receivables from the power sector fell to PKR93.6bn from PKR98.2bn. Recent clearance of 1st tranche payment of PKR90bn approved by ECC in May’21 and further clearances of remaining tranches that are expected in next six months will prompt PSO’s power receivables, mainly from GENCOs by Rs72.9bn and HUBCO by Rs23bn to fall even further.

Receivables from FO sales are not expected to accumulate in the future as FO sales are expected to reduce annually by around 20% due to better availability of substitutes and non-preference of load factor in generation by the government.

Earlier, government under commitment with IMF economic program had approved the increase in electricity tariff by a total of PKR5.65 per unit from April till Oct’21 (amount excludes the scheduled annual hike). This increased tariff collection from the consumers will prompt a projected reduction of PKR850bn in circular debt by FY23 if implemented, circular debt currently stands at PKR2.34tr. Although Govt has negated the implementation of tariffs increase mainly due to political and inflationary issues.

Other measures to ensure further recovery payments include signing new IPPs contracts by changing ROE indexation component under power policy 1994 & 2002. Furthermore, government has also started negotiations with IPPs based on 2012 policy (includes upcoming CPEC projects), convincing IPPs to shift to cheaper fuel sources and revamping DISCOs to ensure minimal distribution losses in the future, the report added.

As per projections made by Insight Securities, these developments and injection of liquidity into IPPs will eventually flow towards PSO which will improve company’s cash position and reduce short term borrowings going forward, which currently stand at PKR96.8bn at 3QFY21.

The research further stated that LNG based receivables from SNGP holds the biggest chunk of total receivables i.e, PKR100bn (May’21), increased by 40% in 11 months from PKR71.2bn in FY20. Although LNG sale volumes have remained stable, while receivables are continuing to pile up on PSO’s books with no resolution in sight. Unless there is a clearance of payments from IPPs to SNGP, this may pose a critical liquidity issue for PSO in near future.

Meanwhile, OGRA introduced several measures to ensure the sustainability of the players in the sector, include shifting to fortnightly pricing, pegging the OMC margin to CPI (NFNE), partial exchange rate pass-on, increasing capital and storage requirements for new entrants in the sector. In addition, OGRA has made positive efforts to cut down smuggled POL products from Iran, mainly HSD.

This will lead PSO to capture around 46% of the recovered retail fuel market share from areas affected by smuggled fuel, approximately raising earning estimate FY21E by approximately Rs2.52 per share.

With respect to share in refinery side, the report indicated that PSO holds 63.5% of equity in its refinery subsidiary, namely Pakistan Refinery Limited (PRL). The refinery has been a loss-making entity for past two fiscal years, mainly due to negative GRMs, exchange losses and reduction in FO volumes. PRL also achieved the lowest utilization (76%) in 2019 (59.3% in 2020) among close competitors ARL (92%), PARCO (88%), NRL (78%), mainly due to depressed upliftment of FO by OMCs as its demand has shrunk drastically in the recent past.

Currently, PRL pays penalties on the non-existence of Diesel Hydro Desulphurization (DHDS) unit, for which the company’s HSD ex-refinery price is adjusted downwards, causing a loss of PKR1.03bn (2020). PRL’s upcoming capex is to be based on Euro-2 standard of HSD set by ministry of energy by installing Desulphurization facility and Replacing hydro-skimming plant with a deep-conversion facility which will produce more HSD and Mogas instead of FO.

In the recent analyst briefing, management of PRL quoted the cost of the second-hand refinery to be upto $0.7bn. These upgradations in PRL are assumed to be financed mainly by 80:20 debt to equity (PSO equity injection).  

The research revealed that the above capital injection will be financially fruitful for PRL and PSO due to the new refinery policy announced in federal budget 21/22, which includes several benefits to refineries. This would boost PRL profitability and dividends for PSO going forward. If the project upgradations go ahead and are completed by 2025. In that case, PSO’s volumes in Mogas and HSD are expected to increase, resulting in improved market share to 48.5%.

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