The government is planning to table a new refinery policy after a gap of almost 23 years to provide incentives – removal of 2.5 percent customs duty on crude oil import and 2.5-10 percent margin protection on high-speed diesel (HSD) and motor spirit (MS) – for local refineries to upgrade product specifications to meet Euro-V standards, experts said.
“Though details on the final draft are awaited… our understanding suggests most of the issues facing refineries will be addressed in the policy. Strict performance criterion in final draft after recent Cabinet meetings is a concern especially when gross refining margins (GRMs) are at historic low of $3/bbl and at par with refining cost due to the ongoing pandemic,” Farhan Mahmood at Sherman Securities said.
He said new policy will improve existing GRMs by 60 percent or $2.0/bbl (net of taxes). Amongst local refineries, Attock Refinery (ATRL) stands to benefit most given higher MS yield. After the benefit, refinery earnings will turn around from FY22. Financing of this huge project (estimated cost of over $1.5 billion) would be a concern unless GRMs increase to pre-Covid level of $6/bbl from existing $3/bbl.
He said the government in upcoming policy has directed refineries to commission upgradation projects by June 2026 allowing them fiscal incentives till December 2027. “Our cost estimates of $1.5 billion for up-gradation are based on Pakistan Refinery’s (PRL) estimated capital expenditure of $01 billion to convert existing plants to Euro-II standards”, he said. “We believe a higher cost is required for Euro-V standard.” Few performance criterion in revised draft may delay project. Besides the fact that GRMs are at historic lows, there are other reasons which may delay project.
There are concerns that additional benefit of duty protection on MS and HSD will not be utilized prior to EPC contract and there are limitations/capping on the usage of additional funds, he said. He believed refineries may contest and apply waivers since additional benefit along with recurring earnings may help finance only 10-15 percent of the project at current production and GRMs.
In the long run, it is unclear whether duty protection on HSD and MS will continue beyond December 2027, however refinery earnings will be exempt from income tax for 10 years after commissioning of projects which will slightly offset the negative impact. Meanwhile, there is a clause restricting refineries from distributing additional income through dividends. “We believe refineries may compel government to extend duty benefits as we saw in last policy,” he said. If government extends waivers on few criterion and industry GRMs improve to pre-Covid levels, the policy will likely be ‘positive’ for refineries, he added.
He said risk to valuation includes volatility in global oil prices, movement in currency, movement in interest rates and alteration in margin protection/deemed duty.