A wake up call for ruling junta of Pakistan

Pakistan has an agro-based economy and the country is heavily dependent on imported energy products. As country’s trade deficit is mounting there is need to revisit government policies. The other alarming factors are: 1) extensive borrowing to meet the budget deficit and 2) deceleration in remittances. The added problem is that with the commencement of winter industrial units, particularly textiles units are likely to be a major sufferer and exports of textiles and clothing destined to plunge.

As stated earlier, Pakistan is heavily dependent on imported energy products; any hike in crude oil prices does not bode well for the country, though capital market analysts term the hike good for E&P and downstream companies listed at Pakistan Stock Exchange (PSX). A stronger dollar is likely to keep commodity prices in check, but also expected to make imported commodities more expensive.

Pakistan Steel is closed for months and there are no signs of its commencing production in the near future. Its price has posted 16.4%MoM increase in November, as Chinese producers re-align supply and the government implements a policy of curtailing supply.  This is likely to cause further hike in steel price, which does not bode well for Pakistan

Pakistan is a major user of coal, in cement industry. Coal price drop on Chinese relaxation on mining controls: After reaching a 5-year high, coal price has fallen to US$83.5/ton as the government asked the coal miners to lift up output till the end of end of winter heating season to counter the surging price. The coal price decline has remained slower as the Chinese coal producers were unable to ramp up production quickly due to medium-to-long term supply contracts and time to bring back coal mines into production. Nonetheless, normalizing of seasonal demand post-winters, will likely witness further fall in coal price as China will continue its policy to do away with coal based energy.

Fertilizer is one of the major industries of Pakistan and currently suffers from poor capacity utilization. Added to this is, extremely low international prices of urea, affecting the earnings of local manufacturers. In November its prices rose to US$224/tons as compared to US$201/tons a month ago.  While continuing to recover from lows of US$172/ton seen in July 2015, urea prices remain down 8%YoY as oversupply and weak demand continue. On the domestic front, recovery in international prices is likely to enhance pricing power of local manufacturers, who are already plagued by lower off-take. However, further recovery in off-take remains more likely to be a product of price reduction.

Global cotton prices during November remained higher as compared to last year (up 14%YoY) on the back of continued price recovery. The monthly USDA report featured an increase in global annual production up to 103.3 million bales and virtually no change to world mill-use, resulting in additions to global stocks. Following the global trend, prices in the domestic market remained on the higher side in November. Despite higher-than-expected phutti arrivals, prices of quality cotton move higher because of sustained buying by mills and spinners. Moreover, temporary ban on cotton import from India kept demand of local cotton robust.

This year Pakistan is likely get another bumper crop of wheat but of no benefit. While the surplus can’t be exported, post harvest losses are feared to increase due to inadequate storage facilities. Lack of supporting policies has failed in attracting investors to construct modern warehouses and collateral management companies. Absence of modern silos results in up to 20 percent post harvest losses. Saving this could boost income of farmers and also bring down price of staple grain n the country.

Curtailing oil production ‘an agreement of thugs to rip off consumers’

Without mincing my words I will prefer to call recent agreement of OPEC and non-OPEC members to cut output ‘an agreement of thugs to rip off consumers’. They have agreed to cut output but still don’t trust each other. They even go to the extent of calling each other ‘cheater’. Therefore, some of the members are most likely not to abide any production limited. The business will continue as usual because consumption of energy consumption will increase with the commencement of winter. However, the level of consumption will remain dependent on the drop of mercury level.

Let me explain my assertion that the US and Saudi Arabia were partners in taking oil prices up to US$147/barrel. In fact Saudi Arabia fell in the trap because it was overwhelmed by the hike in price. Although, I fell that I am not competent enough to say this, but just can’t resist from saying. Saudi Arabia just did not bother to look at the number of rigs operating, which exceeded 1900 at one time. The quantum increase in US Shale output helped the country (US) in becoming self sufficient in indigenous oil production. The US is no longer dependent on imported oil, though it is still importing low cost oil from Saudi Arabia.

In my previous blogs I have discussed different themes that included 1) pressure on Iran to cut output 2) Saudi Arabia asked to make the biggest cut? 3) Iran not a threat to Saudi Arabia but US Shale, certainly 4) attempts to penalize Iran and Russia have backfired. The scenario prevailing since 2014 can be summed up in one sentence, ‘Saudi Arabia kept on pumping maximum oil to maintain its market share. It may have succeeded in maintaining the share but petro income nosed dived, leading to extensive borrowing.

After the withdrawal of sanction imposed on Iran, Saudi Arabia felt jittery and feared losing its substantial market share. It completely ignored another harsh reality that due to over three decades of economic sanction, Iran’s output could not be increased. Though, economic sanctions were also imposed on Russia, it managed to take its output above 11 million barrels lately. That is the reason it convinced Saudi Arabia to agree to cut output because it believes that collectively two countries (Russia and Saudi Arabia) now enjoys power to maneuver oil price. Both of them want to ensure that Shale production does not increase certain level.

I will also say that geopolitics play a key role in the supply of oil. Some of the most obvious examples are Nigeria, Libya and Iraq. As and when a reduction is desired, output in these countries is disturbed. This time the issue of pipeline in the US has also affected shale output.  Therefore, the readers may also agree with me that oil output and its prices are controlled by a few thugs; they may appear foes but have common agenda, keep the world under their control.

Pakistan stock market benchmark Index inching towards 46,000

Continuing its strong run, the benchmark of Pakistan Stock Exchange marked another stellar week ended on 8^th December 2016 and closed at 45,387 levels. The rally was driven by high oil prices, continued expansions in industrial sectors and announcements of corporate actions. LUCK announced plans for entry into automotive business through setting up manufacturing plant in partnership with Kia motors, furthering operations in Iraq while expressing intention to bid for DCL's assets, keeping sentiment strong. Other announcements included TREET and ICI’s plans to invest in the pharmaceutical sector, Shanghai Electric sharing a US$9 billion investment plan following KEL’s acquisition and BoD approval of MCB and NIB merger. Additional key news flows included: 1) Continuation of Supreme Court hearings of Panama case, with PM Sharif facing criticism from the court for failing to provide a money trail for asset purchases, 2) GoP raising Rs147 billion through Treasury Bills auctions where cut‐off yields remained stable, 3) cotton arrivals increasing 13.8%YoY for the season, 4) delay in bid opening process for the 40% divestment of PSX and 5) CCP imposing a penalty of Rs150 million on PSO for deceptive marketing. Market leaders during the week were: LUCK, ICI, PIOC, FCCL and AICL; while laggards were: ASTL, EPCL, HASCOL, PSMC and LOTCHEM. However, activity at the Exchange tapered 15.3%WoW with average daily trading volume of about 393 shares. Foreigners remained net sellers for the week, though outflows stood lower at US$24.8 million as compared to US$33.5 million a week ago. Oil stocks is likely remain in limelight as the next week kicks off, following the OPEC and Non‐OPEC meeting to decide on oil output cuts set for tomorrow. Moreover, the US FOMC is scheduled to announce monetary policy next week, with broader anticipations of a 25bps hike in Federal Funds Target Rate (FFTR). However, Fed’s outlook for FFTR trajectory in CY17 remains a risk event for global markets. Resurgence in political noise on Panama case developments remains a possibility, to potentially force some profit taking next week.

The US FOMC is largely anticipated to increase the fed rate in its upcoming monetary review next week  that coupled with a surge in inflationary expectations post Trump victory has pushed the greenback to its 14-year high. Within this context, the upcoming meeting retains particular importance as Fed's economic projection for future rate trajectory can alter the dollar outlook. While most regional currencies have witnessed erosion against US$, the PkR/US$ parity has held its ground. Moreover, GoP's ongoing drive to normalize kerb‐rates is a strong signal of its policy to maintain currency stability. However, going forward analysts fear some decline due to: 1) exports weakness amid lower currency competitiveness in the region, 2) higher oil prices adding to import bill and 3) potential delays in foreign debt flows to support foreign exchange reserves.

We revisit our investment case of LUCK as it has formally announced to further expand its business portfolio. The new list of projects comprise of: 1) setting up of manufacturing plant of Kia motor vehicles, 2) expressing interest in acquiring DCL's 1.134 million tpa Hattar plant, 3) doubling capacity of Iraq JV to 1.742 million tpa and 4) indirect additional exposure in the pharmaceutical business through its subsidiary, ICI (expressed interest in acquiring certain assets of Wyeth Pakistan Ltd). Assuming the DCL acquisition is successful, LUCK's earnings can increase depending on DCL's post acquisition performance. Whereas, doubling Iraq JV's capacity can result in incremental earnings.

Up-gradation of prevailing MOGAS standard (from 87RON to 92RON) and the accompanying launch of high octane variants by OMC's has rejuvenated the drive for volumetric sales growth, as seen in the November’16 figures released by OCAC. Running a preliminary market sizing analysis, some analysts ascertained the impact of these fuels (reportedly deregulated but an official notification is still awaited) on SHELL, HASCOL and PSO's earnings. Moreover, deregulation resonates positives for OMC's, namely: 1) additional cushion against wild swings in cost of supply, as increased costs can be passed on without a lag and higher margins raise earnings profile and 2) low receivables in motor fuels segment, increasing avenues for growth steering clear of liquidity pangs.

Pakistan Stock Exchange closes above 43,000 levels

Delivering persistent returns despite the recent spate of foreign selling (outflow of US$125.7 million since November'16), the benchmark Index of Pakistan Stock Exchange grew 0.63%WoW, gaining 271pts closing at 43,271 points. Supported by OPEC's decision to restrict crude output and resulting movement in global benchmarks (Brent/WTI gained 11.8/8.4%WoW), upstream Oil & Gas climbed higher.

Key news flows during the week were: 1) CPI for November’16 was reported at 3.81%YoY compared to 4.21%YoY in October'16, implying sequential increase of 0.21%MoM, 2) deregulation of 95 and 97RON MOGAS affirmed by Minister stating that 92RON would replace the 87RON previously being supplied, 3) Finance Minister announcing increase in price of petrol and diesel, 4) GoP releasing Rs248.1 billion for various development projects under public sector development program (PSDP) under the current financial year as against a total allocation of Rs800 billion during the previous year and 5) Pakistan Stock Exchange (PSX) scheduled to open bids on Monday, December 5, 2016 submitted by foreign strategic investors and local institutions to for acquiring 40 percent stake of the bourse. Key gainers at the bourse during the week were: EPCL, MTL, ICI and ENGRO, whereas laggards were: NCL, NML and HCAR. Average traded volumes were highest for: BOP, PACE, ASL and WTL. Approaching end of the year holiday season, foreign participation is expected to take a back seat as local funds and institutional investors, favoring blue‐chip plays offering value. Rise in local oil prices have further fueled expectations of a bottoming out of the monetary atmosphere keeping commercial banks in the spotlight.

Gaining 6.9%MoM in November'16, PSX‐100 index stood its ground in what was an eventful month for the world; while global equity markets struggled (MSCI EM/FM down 5%/2%MoM) on policy uncertainties post Donald Trump's election as US President. This was despite persistent foreign selling where outflow for the month rose to US$117.05 million ‐ the highest in CY16. While the entire main-board posted positive returns, Cements led the board returning 15.9%MoM (on anticipated strong growth in dispatches and reversal in coal prices after a short lived rally) followed by Textiles (+9.7%MoM due to anticipated pressure on local currency amid strengthening US$) and Chemicals (+8.0%MoM on reduction in gas prices for industries). Going into December'16, the market is likely to look towards the following, taking direction accordingly: 1) oil price trend in the light of OPEC's production cut agreement and the stance adopted by non‐OPEC producers following the decision, 2) FOMC meeting on December 13‐14 where any potential rate hike can continue prompting outflows and 3) on‐going Panama papers related hearing keeping political pressure intact.

To stimulate growth, news flows have disclosed that the ECC has approved a 33% reduction in gas prices exclusively for industries, bringing down prices to Rs400/mmbtu. As an official notification by OGRA is still pending, lack of clarity remains on the inclusion of certain heads in the concession to be availed. It is general understanding that the gas price reduction extends to general industries that utilize gas as a fuel source including Steel, Glass, Fertilizers (concession available on fuel stock only) and Textiles. While benefiting industries by and large, Fertilizers, the largest industrial consumer of gas, stand to benefit the most followed by Steels and Textiles. Cements, on the other hand, are likely to remain unaffected unless the concession is also extended to captive power generation‐ gas tariff for which is determined under a separate head. In this backdrop, while the Fertilizer sector might enjoy a short‐term rally, a weak demand outlook and depressed international pricing dynamics can continue restricting price performance.

Pakistan stock market continues upward move

Benchmark Index of Pakistan Stock Exchange continued its upward move and touched a high of 43,000 points for the week ended 25^th November 2016. The gain of 625 points (1.59%WoW) was primarily led by E&P companies (on the back of 4.25%WoW increase in crude oil price), cements (on receding coal prices and expectation of robust dispatches) and textiles (on expected announcement of incentive package for the industry).

Average daily traded volume inched up by 4%WoW to 475 million shares where volume leaders remained second tier scrips such as PACE, BOP, PIAA, SMBL and ANL. Leaders during the outgoing week included NCL, NML, HASCOL, ASTL and EPCL, while laggards included SSGC, MEBL, INDU, AKBL and HBL.

Following were the key developments during the week: 1) ECC approving reduction in gas prices for industrial consumers by Rs200/mmbtu, 2) PIA concluding a financing facility of US$130 million, 3) T‐bills yields in the recent auction remaining flat, 4) Pakistan securing an additional US$8.5 billion of investment from Beijing as part of the countries' joint energy, transport and infrastructure plan and 5) Summit Bank Limited announcing to initiate due diligence of Sindh Bank Limited for potential merger/acquisition.

The market is expected to remain volatile, taking direction from the following events in the upcoming week: 1) Panama case hearing scheduled on 29^th November, 2) Monetary policy Statement to be issued on 26^th and 3) OPEC’s meting by the end of this month to finalize output deal where inability of the producers to reach an agreement can keep Oil & Gas sector under pressure. Additionally, the recent trend of rising coal prices may keep cements under pressure while textiles are expected to remain in limelight upon expected announcement of the export incentive package.

After touching the year's high last month (4.2%YoY), CPI inflation is projected to revert back, coming in at 3.82%YoY during this month, implying a limited 0.21%MoM increase owing to muted rise in food inflation (0.2%MoM) and a high base effect. On the other hand, NFNE Core inflation is expected to inch up slightly to 5.3%YoY compared to 5.2%YoY in October this year. Consequently, 5MFY17 CPI/NFNE Core inflation average is expected at 3.91%YoY/4.87%YoY compared to 1.87%YoY/3.79%YoY in the corresponding periods last year. Inflation is expected to tread higher during the rest of the fiscal year, with projection for FY17 CPI inflation at 4.8%YoY, which eliminates room for further rate cut in the upcoming MPS. Moreover, rapid deterioration in current account strength (up 63%YoY in 4MFY17) and rising concerns on global front in the form of dollar and crude oil prices gaining strength are expected to keep the central bank cautious.

Inching up, current account deficit for October’16 was recorded at US$381 million as compared to US$174 million for September'16. Resultantly, 4MFY17 deficit accumulated to US$1.76 billion, higher than US$1.08 billion for the same period last year. The weakness has been led by slowdown in remittance flows and rapidly expanding trade deficit. Foreign investment dynamics have been unpromising so far in FY17, where FDI net inflows were reported at US$316 million ‐ half of US$610 million in 4MFY16. Relief has come in the form of the recent US$1.00 billion Sukuk issue, which has taken 4MFY17 total foreign investment to US$1.4 billion as compared to US$0.95 billion. Going forward, current account weakness is expected to continue where analysts reiterate their projection for deficit at 1.7% of GDP driven by trade deficit and slower remittance inflows.

Following below expected 3QCY16 earnings, AKD Securities revisited its investment case for national Bank of Pakistan (NBP), revising projected CY16/CY17 earnings down by 8.2%/7.6% on account of a higher than expected sequential downtrend in the bank's income streams, both funded and non‐ funded. While interest income was understandably lower on account of PIB maturities during the quarter, brokerage house has expressed its concerns regarding the decline in non‐interest income that was down 20%QoQ despite higher gains utilization. In this regard, fee income was down 28%QoQ followed by 34%QoQ decline in other income. While still appreciative of the bank's concerted efforts in improving its asset quality, higher provisions during the quarter were on account of changes in regulations on consumer financing by SBP (Rs783 million booked in this regard) along with seasonal impact of agri‐financing. Gaining 27%CYTD, the market has been quick in acknowledging the bank's fundamental turnaround. Valuation set is attractive and has room to expand once sentiments further improve on: 1) interest rate cycle reversal drawing close and 2) multiple re‐rating upon formal MSCI inclusion.

OGDC achieves record crude oil production per day

It is not a secret that Pakistan is highly deficient in indigenous energy products. Import of crude oil and POL products eats up billions of dollars every year. On top of that extensive gas and electricity load shedding keeps capacity utilization of industrial units below optimum capacity utilization. The prevailing situation demands accelerating activities of exploration and production (E&P) companies. Pakistan meets around 12 percent of its oil requirement from indigenous resources.

The state owned largest E&P, Oil & Gas Development Company (OGDC) claims it is making extra efforts and one tends to agree with the statement partially. Its latest announcement says that the Company has achieved a record production of 50,172 barrels per day (bpd) of crude oil. By international standard the number may look dismal but for Pakistan it looks enormous, 57 percent of the country’s total crude oil production estimated around 88,000 bpd.

The information disseminated indicates that the Company is all set to inject about 4,000 barrels of additional oil per day, 100 million cubic feet per day (mmcfd) of gas and 400 tons of liquefied petroleum gas, starting with fewer quantities in the first week of December and then gradually going up. This addition would come from Kunar Pasakhi Deep field in Sindh which had been held up due to disputes and court cases.

Pakistan inching towards acute shortage of POL products

I am a great fan of Dawn newspaper and Khaleeq Kiani. The story published on Monday Pakistan's fuel reserves fall below strategic levels highlights a few points. These include: 1) Prime Minister and Ministers don’t have time to focus on strategic issues of national importance, 2) they are also devoid of acumen required for strategic planning and 3) bureaucracy, picked up by politicians also tows the lines of their big bosses.

Knowing Khaleeq, I will not mince my words and say without hesitation that this story should have appeared much earlier. International price of crude oil took a nosedive in 2014 and since then has been hovering around less than USD50 per barrel. This provided an excellent opportunity to Pakistan to 1) construct additional storage facilities and 2) build strategic reserves. However, the policy planners and decision makers failed on both the fronts miserably.

Some time back I had posted a blog that a few refineries were busy in creating facilities to add their production and broaden product mix. Lately, I also posted a blog highlighting acute shortage of HOBC. Even at that time I was fully convinced that refineries were operating below optimum capacity utilization and country’s dependence on imported white oil products were on the rise.

This reminds me that at one stage three new refineries were on cards but even PARCO deferred it Khalifa point refinery. This clearly showed ‘confidence deficit’ and I could not resist from saying that if local investors are shy the country should not expect foreign investment.

Please allow me to say that the worst hindrance in establishing of energy and power generation companies in Pakistan is ‘circular debt’. Following policies of international donors blindly has put the cart before the horse. Added to this is failure of the government to contain blatant pilferage of electrify and gas. The menace prevails due to the absence of political will and inefficient regulatory and legal framework.

The incumbent government, since coming into power has been issuing new/revised deadlines for getting rid of load shedding, I often fear that it is hoping against the hopes. The reason is simple, unless the government makes required structural changes, stopping pilferage is almost impossible. Besides this, the government has to prove by act that is serious in overcoming pilferage and recovery of outstanding dues. Else be ready to face even the worst conditions.