The Petroleum Division has reportedly drafted a new policy for the Refining sector in Pakistan, with the aim to foster investment in both new refineries and up-gradation projects by the existing refineries. The Policy also aims to ultimately enable complete deregulation of distribution of petroleum in Pakistan – where the upgraded and modernized refineries will be competing for supplies. The government is envisioning completion of both the upgradation projects (with new refineries) and deregulation to be achieved after 30 June 2026. Note that the draft Policy has not yet been tabled with the ECC for approval.
Incentives for existing refineries
Upgradation projects by the existing refineries in Pakistan are likely to entail addition of new units for (i) the conversion of unwanted furnace oil into more useful fuels, and (ii) lifting the quality standards of indigenous fuels (petrol and HSD in particular). Note that furnace oil comprised c.25% of total refinery production in FY19/20 (about 3.0/2.2mn tons); and most refineries produce petrol of less than 92 RON (imported), while HSD is only Euro-II compliant (Euro-IV available in India). The salient features of the proposed incentives are given below:
Deemed duty on HSD of 7.5% will be replaced with an import duty of 10%. A 10% import duty will also be applied on motor gasoline (petrol) from none before. The 10% duty will be in place from 1 July 2021 to 30 June 2026, beyond which it will decline by 1% pa to 5% by 1 July 2030 and remain fixed at 5% thereafter.
Income tax holiday of 20 years (from the time of commissioning) to the extent of production from the upgradation projects
Exemption of import duties and sales tax on machineries and equipment
Note that refineries must obtain an approval for the project from the government before 31 December 2021, to benefit from the above incentives. In case they do not obtain the approval, they will be barred from selling motor gasoline and diesel in Pakistan after 30 June 2022. Similar penalties will apply to refineries that do not meet the said deadline for completion of the projects (of 30 June 2026).
Our perspective: This is a good step by the government, in our view. The upgradation projects will cost more than US$300-400mn and take at least three years to complete. Undertaking it would not be feasible for most refineries in Pakistan, given the ongoing phase-out of furnace oil leading to compromised utilization rates and thin profitability (losses in FY20). The 2.5%/10% additional import duty on HSD/Mogas will significantly lift overall profitability (all else the same). The increased profits will enable the refineries to accumulate cash and avail debt efficiently for the project (in addition to potential capital calls), in our view. We estimate average gross refining margins (GRMs) to increase by US$1.0-1.5/bbl (because of the additional duties), and the annualized bottom-line impact on listed refineries (until the commissioning of upgraded plants) are given below.
Pakistan Refining stocks have rallied c.50% in the past six months (NRL has tripled), in anticipation of new policy incentives for the sector. The measures are generous indeed, compared with past government policies. We think that the market has priced in the estimated benefits of the proposed measures to a great extent. However, we highlight that ATRL boasts a stock portfolio value of c.PKR150/sh (with 20% discount) which is nearly 65% of the stock price (refinery turnaround not fully priced in, in our view).
Incentives for new refineries
So far, there is only one new project committed by the Saudi government in 2019 – a c.US$10bn project of 250,000-300,000bpd capacity, potentially including a petrochemical complex and entailing about five years of construction. We understand that land acquisition and other planning of the project are presently underway.
Salient features of the incentives for new refineries are summarized below.
Incentives only for a deep conversion refinery (approved by the Petroleum Division before 31 December 2021)
Twenty years’ tax holiday from the time of commissioning
Exemption of import duties and sales tax on machineries and equipment
Import duty of 10% on HSD/Mogas will also apply for the new refinery (for the first 5yrs with a declining rate towards 5%), as long as it starts construction before 30 June 2024.
Our perspective: Such a refinery will significantly lift Pakistan’s indigenous petroleum production, given c.55% of total consumption is through imports (equivalent to 150,000bpd). If the new refinery has a Petrochemical complex, Pakistan will materially reduce its imports of such chemicals and plastics (about US$2.0bn pa). Given the size of the Saudi-financed plant and upgradation projects by existing refineries, the sector can ultimately become a net exporter for Pakistan, in our view.
Courtesy – Intermarket Securities Limited.