Karachi, June 16, 2021 (PPI-OT): Petroleum Development Levy – a daunting task

The recently announced Federal Budget FY2021-22 has generally been well-received. However, one cannot help but sense an aura of optimism that emanates particularly from non-tax revenues.

Considering that the PDL has already fallen well below the IMF’s floor of Rs15/ltr (Rs2.97/ltr on MS and less than Rs5/ltr on HSD), we believe that the government will have to take some unpopular decisions in the coming year to meet the set target of Rs610bn.

The government has already started to pass on (albeit partially) the impact of rising oil prices in the latest price revision. It seems then that a hefty increase in retail prices of POL products (Rs~25/ltr in MS and ~Rs20/ltr in HSD) in the coming year is writing on the wall unless oil prices fall drastically by some miracle.

Revenue targets carry an aura of optimism

The recently announced Federal Budget FY2021-22 has generally been well- received. However, one cannot help but sense an aura of optimism that emanates particularly from non-tax revenues. We speak here of the colossal Petroleum Development Levy (PDL) target of Rs610bn which is substantially higher than the Rs450bn budgeted for FY2020-2021. Not only that, this is also the single largest source of non-tax revenue after SBP profits.

Crude oil vs. PDL

While the government may have surpassed the FY21 PDL target with collection being said to have crossed the Rs500bn mark, we highlight that the depressed crude oil prices during the year did afford the government the luxury of charging a higher PDL on both Motor Spirit (MS) and High Speed Diesel (HSD), particularly in 1HFY21.

However, we are about to enter FY22 with crude oil prices hovering around the US$70/bbl mark. And with vaccination drives against Covid-19 in full swing across the globe, things seem to have slowly started to return to normal where oil prices are not expected to re-exhibit the volatility seen this year. For instance, witnessing an oil price crash of the likes of Apr-2020 seems a far-fetched idea, at least in the foreseeable future.

Considering that the PDL has already fallen well below the IMF’s floor of Rs15/ltr (Rs2.97/ltr on MS and less than Rs5/ltr on HSD), we believe that the government will have to take some unpopular decisions in the coming year to meet the set target.

We estimate that with a very reasonable 10% YoY increase in volumetric sales in FY22 (considering the low base), the government will have to charge an average of Rs27.5/ltr as PDL to cross the Rs600bn mark.

In a slightly more optimistic outlook where volumetric sales increase by 15% YoY, the average levy needed to collect Rs610bn would still be about Rs26.5/ltr.

We highlight that in the outgoing year, the average PDL stood around Rs20/ltr on MS and Rs21/ltr on HSD.

A rise in prices is inevitable

We highlight that the above estimates fall broadly in line with the Finance Minister’s comment of the PDL hovering around Rs25-30/ltr this year. It seems then that a hefty increase in retail prices of POL products (Rs~25/ltr in MS and ~Rs20/ltr in HSD) in the coming year is writing on the wall unless oil prices fall drastically by some miracle. The government has already started to pass on (albeit partially) the impact of rising oil prices in the latest price revision.

Now, assuming the government takes the unpopular decision and meets the set target, let us consider two very immediate implications. The rising POL prices would definitely feed into inflation while the impact of such a drastic rise in prices may also hamper overall demand.

Despite recent higher inflation (where 75% of it had been driven broadly driven by a handful of food items), SBP’s inflation target for the medium term remains unchanged between 5%-7%. Moreover, the output gap is expected to remain negative in FY22F, despite the current recovery.

Our readers should by now appreciate the challenge posed by the enormous PDL target. Given that the overall revenue targets are already quite stretched, if the government fails to achieve the PDL target, it may have to rely on debt financing to cover the shortfall. A more likely result (empirically speaking) of missing the target would be a cut in the Public Sector Development Program to balance the equation.

Such consequences would undoubtedly stand as major challenges for a government looking to catalyse growth. It is pertinent to note that the above calculations are based on the assumption that crude oil prices remain constant at current levels. However, in a bullish oil market, things would only get more difficult. Buckle ups!