Govt to finance 26% in refineries upgradation projects

Ibn-e-Ameer

The government will contribute 26 percent of funds to finance the up-gradation projects of existing refineries in Pakistan in the new proposed Policy 2021.

Sources told Newztodays.com that Petroleum Division had moved a revised summary to the cabinet committee on energy (CCoE) for approval.

Earlier, the petroleum division had tabled a summary before CCoE for approval. However, Asad Umar had raised questions over the upfront tariff of 10 % for existing refineries.The CCoE had also raised questions over the mechanism investment on up-gradation projects out of incremental revenue.

Sources said that in the revised draft, the petroleum division had informed CCoE that refineries will investment 74 % whereas government share out of incremental revenue would be 26 % for the up-gradation projects of refineries.

Now, CCoE will take up a summary in the upcoming meeting.

Earlier, Economic Coordination Committee (ECC) has advised the petroleum division to table a summary of oil refinery policy before the cabinet committee on energy (CCoE) for approval.

Petroleum division had sought approval of economic decision making body to approve new refinery policy. However, it referred the case to CCOE for approval.

Earlier, the finance division has proposed 10 percent protection as an incentive for petroleum refineries in budget 2021-22.

The petroleum division had proposed several incentives in the new oil refinery policy 2021. It had also moved a summary to Economic Coordination Committee (ECC) for approval of incentives for petroleum refineries.

However, the government had decided to approve these incentives in budget 2021-22. Now, the finance ministry had introduced these incentives in the finance bill 2021-22.

CUSTOM DUTY

The finance division proposed 2.5% CD and 0% ACD on crude petroleum oil for registered oil refineries as an incentive for one year in Fifth Schedule.

It will be for the up-gradation of existing refineries to produce environmentally friendly EURO-V specification petroleum products and attract investment in new profound conversion integrated projects.

It further proposed to reduce customs duty (CD) on High-Speed Diesel to 10% in the Fifth Schedule.

The finance division further proposed to increase customs duty (CD) on motor sprit from 5% to 10% in Fifth Schedule.

SALES TAX

It proposed to draw zero ratings from crude petroleum oil to process by refineries. It further offered to withdraw zero-rating on Parts and components of zero-rated plant and machinery.

Finance Ministry further recommended withdrawing zero-rating on importing plant and machinery by petroleum and gas sector and supply.

INCOME TAX

It proposed exemption from tax on income of profound conversion new refineries and BMR projects of existing refineries for ten years. The Finance Ministry also proposed to reduce the rate of WHT by 3% on oil field services.

The FBR also proposed to withdraw withholding tax on CNG sector and also withdrawal of withholding tax on certain petroleum products.

The incentives are budget proposals in the custom manual of FBR. In the policy, oil refineries had agreed to reduce the duty on crude import to zero.

Refineries say that the 2.5% duty will reduce refineries’ incentives to half.  At least refineries had gained in products duty structure but will positively impact the overall context.

Reduction in Turn over tax from0.75 to 0.5 is gain, sales tax on crude import is loss and cash flow issue with funds recovery from product sales. However, there will be an issue for Naphtha exporting refineries.

Earlier, the government had decided to approve incentives for oil refineries in the budget 2021-22. However, these incentives will be applicable from January 1, 2022.

Earlier, the petroleum division had moved a summary to the economic coordination committee (ECC) for formal approval. However, the ECC has not discussed it so far.

Now, the government is considering the inclusion of the incentives in refineries in the upcoming budget for refineries that the petroleum division has proposed in the new refining policy 2021.

Sources said that the refineries are likely to collect incremental revenue of around Rs 16 billion per annum following 10 percent protection. However, government will seek commitment from refineries to invest around $3.5 billion for upgradation. 

Requirement of Oil

Pakistan meets 31% of its primary energy requirements through oil and refineries of Pakistan also contribute in meeting oil needs. The consumption of petroleum products in the country during FY 2020 remained around 17.63 million tons.

The indigenous crude/condensate processed during FY 2020 by oil refineries of Pakistan was around 3.09 million tons per annum (MTPA), meeting only 16% of total requirements, while 84% of requirements are met through imports in the shape of crude oil (6.71 MTPA) and refined petroleum products around (8.08 MTPA). The deficit crude oil requirements are met through imports from Saudi Arabia, Abu Dhabi (UAE), and open markets from the Gulf region.

The current installed crude oil refining capacity in Pakistan is around 20 MTPA. The indigenous and imported crude is refined by five (05) major refineries.

However, four out of five refineries in Pakistan are based on old technologies such as hydro-skimming. The fifth refinery i.e. Pak Arab Refinery Limited (PARCO) is using semi-conversion technology which is also more than twenty (20) years old.

These refineries upgraded their plants during 2015-18 and installed Diesel Hydro Desulfurization (DHDs) for producing Euro-ll specification Gasoil (Diesel) and Isomerization plants for enhancing the production of Motor Spirt (Petrol) at a cost of around Rs. 75 billion.

Funds Requirement

Oil refineries of Pakistan are still striving to produce Euro-V specification fuels for which they are struggling with the issues of sustainability, refining efficiency/quality, the environmentally friendly product through major up-gradation with the latest technology requiring substantial investment US$ 2 to $3 billion, which could be arranged by the refineries from big lending institutes/banks subject to the improvement of their balance sheets.

Refineries’ recent Profit/Loss position indicates they have been facing losses and need the financial support of the government to improve their financial position for requisite loans.

New Refineries Requirement

Besides, based on the fuel demand projections, the country will be needing at least two (02) new state of the art, Deep Conversion Refineries with each having the capacity of 11-13 MTPA (approx. 250,000-300,000 BPD) within the next 7-10 years at a capital cost over US$ 6-8 billion for each refinery.

Setting up new oil refineries and upgrading existing refineries of Pakistan is a highly complex and capital-intensive business requiring years of lead time.

Moreover, potential investors require a clear government policy with meaningful incentives/commitments prior to making any investment decision.

In October 1997, the Government of Pakistan (GOP) issued Petroleum Policy 1997 which also provided various Policy incentives, including the refinery pricing formula, for upcoming refineries in the country.

Subsequently, a number of policy decisions were taken by Cabinet from time to time for deregulation and commercialization of the refining sector. In this regard, the government approved an Incentive Package under a policy on 27th April 2018 for all new state-of-the-art deep conversion Oil Refinery projects including the expansion of existing refineries of a minimum of 100,000 BPD refining capacity to be set up anywhere in the country. The said Policy is required to be reviewed and made part of a comprehensive policy document.

Keeping in view this, Petroleum Division carried out a consultation process with the oil industry and other stakeholders and prepared a draft Pakistan Oil Refining Policy 2021 for the up-gradation of existing refineries to produce Euro-V specification products and attracting new state of the art deep conversion refinery through fiscal support based on the revised duty structure which is submitted for consideration and approval of the Cabinet.

Pricing Regime

The Product Pricing Formula of refineries of Pakistan shall be based on “True Import Parity Price” to be derived from Arab Gulf Mean FOB spot price, or if not published shall be derived from Singapore Mean FOB price.

All other elements including Premium, Freight Charges, Port Charges, Incidentals, and Import Duties shall be added in the above FOB to arrive at True Import Parity Price.

The government will add Ad valorem taxes to arrive at the final consumer price. Additionally, it will also add prevalent Inland Freight of imported crude oil to a refinery for upcountry refineries.

There shall be no import duties on import of Petroleum Crude oil, being the main raw material, by Refineries themselves. The finished products, however, shall be subject to import duties notified by the competent authority from time to time.

There will be no guarantee of the rate of return for existing, or new, refineries provided by the regulator or the Government of Pakistan.

The government shall allow refineries to retain a certain portion of export proceeds in foreign currency.

10% Protection

There shall be a 10% import duty on Motor Gasoline and Diesel of all grades as well as imports of any other white product for fuel for any kind of motor or engine, effective from January 1, 2022, to December 31, 2026. The rate of import duty would then drop one percent per annum and reduced to 5% on January 1, 2031. The government shall maintain at 5% thereafter subject to up-gradation.

It would give the pricing regime for new Refinery projects that shall be no less favorable than the prevailing mechanism till deregulation.

Fiscal Regime

New Refinery Projects

The incentives will be available for all new deep conversion oil refinery projects of a minimum of 100,000 BPD refining capacity for those projects starting the construction before December 31, 2025.

There will be a 20-year income tax holiday of all taxes under the Income Tax Ordinance 2001, from the date of commissioning of the project. 20 years tax holiday period has already been provided under clause 126 (BA) of the Income Tax Ordinance 2001.

 Federal Government shall facilitate for similar exemption of provincial and local taxes.

Construction, Operations and Engineering services performed In Pakistan, whether by local firms or foreign firms operating in Pakistan, as well as procurement of any local materials, shall remain subject to applicable local taxes, whether provincial or federal Projects shall be exempt from the application of the Companies Profits (Workers’ Participation)Act 1968 and Workers’ Welfare Fund Ordinance 1971.

Federal Government shall facilitate for similar exemption of provincial statutes if any.

Upgradation of Existing Refineries of Pakistan

The government will encourage all existing refineries to upgrade and modernize to produce environmentally friendly fuels as per specifications.

There is no restriction on the technology, equipment, or process to qualify for such up-gradation, provided that it results in final finished products meeting the agreed specification notified by Petroleum Division before June 30, 2021 l.e. Euro-V.

There is no restriction on the technology, equipment, or process to qualify for such up-gradation, provided that it results in final finished products meeting the agreed specification notified by Petroleum Division before June 30, 2021, I.e. Euro-V.

This could include upgrades, expansions, and bottom-of-barrel up-gradation, whether individually or jointly by the existing refineries of Pakistan.

The upgrade/modernization/expansion projects as committed by the existing refineries as referred at clause 3.15, shall be eligible for the following fiscal and tariff incentives, to the extent of such upgrade/modernization /expansion project.

There will be a 10-year income tax holiday of all taxes under the Income Tax Ordinance 2001, from the date of commissioning of the upgrade/modernization/expansion project.

There will be an exemption from customs duties, surcharges, withholding taxes, or any other levies on the import of any equipment, or material to use in the refinery without any precondition for certification by the Engineering Development Board.

Federal Government shall facilitate for similar exemption of provincial and local taxes.

Segregated Account

The fiscal incentives in 3.14.1 to 3.14.3 shall be available to exist refineries to the extent of upgrade/modernization/expansion under this Policy. The existing refinery shall have obligation to maintain segregated accounts to ensure the applicability of the same.

Upon receipt of undertaking from refineries, Petroleum Division shall provide a waiver (‘Waiver”) for the Refinery to continue marketing its products, until the agreed completion date of the up-gradation (not later than December 31, 2026), from the fuel specifications notified by Petroleum Division as on June 30, 2021.

The government shall not allow the refineries to sell their products in Pakistan if they doe not give undertaking and meet the notified fuels specifications, after June 30, 2022.

They will provide an undertaking to upgrade within a timeframe to achieve planned milestones. Failure to meet the timelines will result in initially a default notice with an allowed cure period. Failure to meet the milestones shall result in the suspension of the Waiver with the intent that the government shall not allow oil refineries of Pakistan to market the inferior specification products until it gets back on the agreed milestones and timelines.

Special Reserve Account

Each refinery will maintain a” Special Reserve Account” for Up-gradation/Expansion in a separate bank account in the National Bank of Pakistan.

The refinery will transfer any incremental revenue to the Special Reserve Bank Account and will appear separately in the Company’s books of accounts, to exclusively utilize for up-gradation and/or expansion projects. The refinery will not utilize it for distribution of dividends or adjustment of losses or any other general corporate purposes of the existing refineries.

OGRA will monitor the up-gradation/modernization/expansion projects and submit a quarterly work assessment report to Petroleum Division based on the refinery’s work plan.

The government may suspend the incremental tariff protection pricing structure of any refinery, if there is a major irregularity in the work assessment Ogra finds till the time the respective refinery achieves the required milestone.

 The monitoring mechanism

1. a) Ogra will appoint A Third-Party Consultant to review the progress against committed timelines and key project milestones.
2. b) Any failure to achieve the timelines, would lead to withdrawal of incentives.
3. b) Upon any Delay/Default: Refinery will immediately inform OGRA of any foreseen delay in achieving a committed timeline and the underlying reasons.

c) In case Refinery does not fulfill commitment after a lapse of six months, the OGRA shall withdraw the Pricing Incentives for that particular Refinery.

However, once the particular Refinery achieves the milestone, the pricing incentive would again be applicable.

1. d) Project Relinquishment: If at any stage a Refinery decides to relinquish the project, then it has to pay back all incremental amount, net of already incurred expenditures, earned so far from the revised tariff structure.

e)

For the purpose of this clause, Force majeure shall mean any circumstance that is not within the reasonable control and is without the fault or negligence of the oil refineries of Pakistan wishing to rely on the circumstances and may include: flood, pandemic, tempest, or other adverse weather conditions, acts of God, war, insurrection, sabotage, strikes, lockouts or other industrial action, compliance with any acts, regulations by-laws, order or restrictions that materially adversely affects the economics and sustainability.

Undertaking

Each Refinery will submit a bank guarantee of Rs 500 million upon the undertaking of the refineries for up-gradation/modernization/expansion projects but not later than December 31, 2021. The government will release a guarantee upon the finalization of Financial close/FID for up-gradation and expansion of projects.

The government will carry out an annual Audit of the Special Reserve Account by the independent statutory auditors of the refinery, one of the big four audit firms operating in Pakistan.

Oil refineries of Pakistan will use any incremental revenue deposited into the Special Reserve Account exclusively for the up-gradation/modernization/expansion projects, accounting for no more than 40% (net of taxes) of the total project cost, while refineries will fund the remaining 60% on their own balance sheets in the form of corporate debt and/or sponsors equity.

The government will discontinue import duty tariff protection under this policy upon reaching this 40% revenue.

Deregulation in the Future

The objectives of this policy include a shift to complete deregulation on pricing, within a time to allow the benefit of competitive forces to pass on to the consumers.

The government will give oil refineries declining tariff protection for 5+5 years’ time period as mentioned in clause 3.12, after which there shall be deregulation of the market where all refineries will compete with each other, existing and new, as well as with imported product.

All Oil Marketing Companies will be free to set the prices themselves, on the quality of fuels, the location (including the abolishment of the Inland Freight Equalization Margin).

The government has already done for Hi-Octane Ron 97 today. However, even in this environment, the product pricing at the pumps operating under the banner of Pakistan State Oil shall be a market benchmark. Other OMCs may charge more, or less than the PSO prices depending on the level of service, the convenience of location, or quality of services, that the market can bear.

The target date for full deregulation is December 31, 2026. This is the same date for the completion of upgrades of existing oil refineries of Pakistan.

However, since the import duty tariff protection to the existing oil refineries is to continue for another 5 years (on a declining basis) therefore, Government may choose to continue for a further 5 years or withdraw such incentives on December 31, 2026, to fully deregulate the market in consultation with the existing and new (under construction) refineries.