Furnace oil: Embrace it, don’t destroy it

The furnace oil uplifting issue is finally getting attention from the ECC, as news reports suggest CCoE ordered immediate lifting of FO from local refineries. However, the crisis is nowhere close to be over.

It is a structural issue, not a seasonal one. There was a crisis last year and another one is in the making. The issue was picked up in this space on 9th November 2018 (for details read “No end to furnace oil love affair“) and it took three weeks for authorities to realize; this speaks volume for government capacity and competence in handling the energy woes.

Anyhow, the fear is that, the gravity of the problems is yet to be understood by government. There is a meeting scheduled to work on uplifting the FO in short term, come up with medium term plans of exporting surplus FO produced by local refineries and long term plan of upgrading refineries to deep conversion by installing hydro crackers to convert the FO into other products.

Furnace oil is primarily used for power generation in Pakistan; with new capacity additions, reliance is tilting on cheaper alternatives (RLNG, coal and renewable); in days of low demand (winters), most FO based power plants, which are low on NTDC merit order, are closed.

But there are negative externalities for local refineries, E&P companies and imported petroleum handling port and storage capacities. Oil refining plants in Pakistan are hydro-skimming where FO production cannot stop without shutting down plants. Hence, in case of no local FO production, there is no production of other fuels such as HSD (diesel) and Mogas (petrol).

The refineries use local and imported crude for making petroleum products, and in case of refineries’ shutdown, there is no usage of local crude oil produced by domestic E&P companies (local crude cannot be exported due to technical reasons). And in turn, associated fields will stop producing gas as well, because if oil is not extracted from a field, gas cannot be produced from it either.

The consumption (demand) burden of locally refined products has to move towards imported, and even the crude that is imported for local refineries has to be replaced by imported petroleum products. Unfortunately, the port handling capacities in Pakistan do not allow any significant increase in volumes which in itself is an issue in days of emergencies or high demand – remember petroleum supply crises in winters couple of years back when the delays in import of 1-2 containers created shortage in upcountry. The country simply does not have enough strategic oil and products reserves.

Isn’t the story scary? Well, the costs on exchequer, job loss, and most importantly on balance of payment due to high imports of petroleum products are yet to be incorporated in the complex equation. The simple one liner policy advice is that the country cannot afford to let the local refineries close down.

Today’s meeting and future course of actions are to work on finding solutions with refineries up and running close to full capacity. But first, those who are responsible for importing two containers of FO(146k tons) in October and another container (68K tons) in November should be taken to task; as it is sheer negligence on part of petroleum ministry to let that happen when the uptake of locally produced FO is already in jeopardy.

There should be a ban on importing FO by PSO and others without the ECC approval. Secondly, in winters, there should be a way to move up FO based power plants on the merit list. The NTDC merit list of power plants is based on variable fuel (marginal) cost; and FO based plants are lowest in priority.

The most efficient FO plant’s actual cost in Oct18 came at Rs13.96/unit versus Rs9.40 and Rs5.69 for RLNG and coal based plants, respectively. Hence, on cost basis, there is no or little scope for burning FO in power production. But in crisis, out of box solutions are warranted.

The domestic FO prices are to be revised down as share of lowering cost has to be divided between refineries and government. The refineries are commercial organizations and shutting down will have them incur fixed cost without any production. Hence, government has to negotiate on GRM (gross refining margins) for FO to reduce the price.

Plus, the GRM on HSD and Mogas can be increased to compensate the lower margins on FO. With oil prices tanking, government might have room to adjust taxes/margins on petroleum products without increasing consumer prices.
Concurrently, a mechanism to export FO should be formulated. The global demand of HFO (mainly produced in Pakistan barring Attock refinery) is low and it can only be sold to hydro crackers as feedstock to produce other products.

It is pertinent to note that with changing global environmental laws and regulations, after 2020, the HSFO (high sulphur furnace oil) may not be allowed to be shipped for many destinations. Hence, the long term solution of converting domestic hydro-skimming refineries to deep conversion should start soon. It takes nothing less than 4-5 years to install new plants and it might not be feasible for all refineries to do individually; so a shared one plant in mid-country (near Parco) is the doctor’s order. The sooner it is, the better.

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