Decoding Pakistan’s Circular Debt

Recent government estimates point towards the gas sector circular debt to have increased to PKR900 billion by end November 2022, compared to PKR719 billion as of March 2022. The companies affected by the debt include OGDC, PPL, SNGP, SSGC, and PSO.

The increasing quantum of circular debt in the gas sector has been detrimental to the energy security of the country in the recent past. Not only has it constricted the liquidity positions of the companies in the energy chain, but has also become a point of contention with the IMF.

The circular debt can be traced to: 1) diversion of costlier RLNG to Natural Gas consumers, 2) hike in UFG Losses, primarily theft, and 3) delayed gas tariff revisions.

Rising circular debt has put Pakistan in a vicious cycle. It has been widely documented that the increasing quantum has resulted in liquidity constraints, especially for the Exploration & Production companies, OGDC and PPL.

The stock of receivables on the companies’ books has increased from a collective PKR306 billion at the end of FY18 to PKR892 billion at the end of the September 2022 quarter.

With the mounting receivable burden on the companies, exploration activity has been subdued, leading to an inability to arrest the fall in production due to natural decline in reserves.

Gas production in the country has fallen from 3,997 MMCFD in FY18 to 3,390 MMCFD in FY22. This comes at a time when the demand for gas and energy is increasing.

This gap is being filled by imported RLNG, which is diverted to natural gas consumers and billed at lower rates, adding further to the stock of gas circular debt—putting the country in a vicious cycle.

Trade debt leads to lower exploration activity, ultimately leading to lower production levels, increasing the diversion of RLNG to natural gas consumers, which leads to lower cash collection, adding to the receivables, and the cycle continues.

Government is succumbing to the peculiar situation. Thanks to IMF’s impending ninth review, the government has finally taken notice of the situation in the gas sector and constituted a team to address the circular debt situation.

However, the agenda for the committee is short-term as it only aims to address the circular debt that has built up over the years, while not addressing the greater issue of policy measures required to arrest the buildup of the circular debt going forward.

The government would have to hike gas tariffs if it hopes to reduce the buildup going forward—a measure that has also been stressed by the IMF. Prime Minister Shehbaz Sharif has hinted towards the same in his recent address, paving the way for euphoria in the market.

From the vantage of E&P companies, specifically OGDC and PPL, any resolution of the receivables on the companies’ balance sheets would result in valuations being unlocked for the juggernauts.

If the government is able to overhaul the balance sheets of OGDC and PPL, it may lead to a re-rating in the multiples, unlocking upside potential.

Pakistan: Oil and gas production on the decline

According to a report by Pakistan’s leading brokerage house, Topline Securities, during FY22, oil production in the country declined by 3%YoY to 26.8 million barrels or 73,400 barrels per day (bpd). Oil production in the country during 4QFY22 was down by 6%YoY as against 17%YoY increase in 4QFY21. 

This was largely due to: 1) decline in production from Nashpa, Adhi, and Makori East oil fields, and 2) no addition of any sizable oil field. On a QoQ basis, the decline in oil production was due to annual turnaround at Meyal, Jhandial and Pariwali.

During FY22, Pakistan gas production has come down by 2% YoY to 3.38k mmcfd which is largely in line with last 5-year average production decline.

Gas production in 4QFY22 contracted by 2% YoY due to: 1) their association with lower oil production, and 2) lower offtakes due to annual turnaround and maintenance. 

During 4QFY22, gas production was almost flat or up by paltry 1%QoQ despite lower offtakes from MARI due to annual turnaround of Foundation Power Company Daharki Limited (FPCDL) and Dakhni and Maramzai fields during the quarter.

As new block auctions were held last year, exploration activity in the new awarded blocks is likely to increase. Production flows in FY23 could also be higher due to the recent discoveries in FY22.

In FY22, Geological and Geophysical (G&G) activities remained on a higher side where 3D seismic acquisition rose to 1,913 Sq. Kms. However, 2D seismic activities decline to 2,507 Sq. Kms.

During 4QFY22, Geological and Geophysical activities showed an increase, with 3D seismic acquisition increasing to 1,132 Sq. Kms, while 2D declined to 577 Sq. Kms. Moving forward, there are 7 seismic surveys of 2D and 3D which are going to be conducted during 1QFY23.

In FY22, meterage drilling increased by 43%YoY as the numbers of well spudded were reported at 58 as compared to 50 in the same period last year. Drilling activities (meterage) rose by 20%YoY, but fell by 19%QoQ to 44,500 meters during 4QFY22.

Overall, 8 wells were abandoned in FY22 as against 6 in the same period last year. During 4QFY22, the exploration and production companies encountered 3 abandoned wells which were Exploratory (Mian Miro Deep -1, Surghar X-1 and Bewato-1.

For 1QFY23 3 exploratory and 4 development wells have been planned for.