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.
