Brace for impact: The Middle East war has reached Pakistan

The war in the Middle East has formally landed on Pakistan’s shores.

The government’s announcement of an emergency Rs55 per litre oil price adjustment on Friday night could well be the first of more to come. More so, the sheer availability of fuel is now an open question, despite the 28 days of stocks that we were assured the country maintains.

Dawn spoke to oil industry executives who say oil markets are now roiled with an uncertainty never seen before. The closure of the Strait of Hormuz has taken an estimated 20 million barrels per day (mbd) cumulative off global oil markets in what is being called “the largest oil supply disruption in history”. There is no precedent in the past when a quantity of this magnitude was suddenly removed from the market, not even in the oil embargo of 1973.

The impact, according to a note by Goldman Sachs circulated on Friday, is that “oil prices, especially for refined products, would exceed the 2008 and 2022 peaks, if Strait of Hormuz flows were to remain depressed throughout March”.

This is no minor warning. 2008 was the year oil prices hit a historic high of $147 per barrel, driven mostly on speculative buying. And 2022 was the oil and gas price shock when Russia, one of the world’s largest oil producers, invaded Ukraine, one of the world’s largest gas exporters and transit routes. That war drove oil prices above $120 per barrel. If the ongoing closure of the Strait of Hormuz persists, both these peaks could be surpassed.

Unfortunately, Pakistan’s economy does not handle energy price shocks very well. Since 2008, the country’s oil sector has seen at least four separate crises, during which either the supply chain broke down, creating aggravated fuel shortages, or attempts by the state to restrain prices at the pump, despite spiralling international prices, ended up aggravating inflation and fueling macroeconomic instability.

Pakistan’s recurring oil crises

Some of these crises were brought on by sharply rising prices, others by sharply falling prices. The so-called “petrol crisis” of 2015 was blamed by the then government on a sudden spike in demand due to a steep fall in the price of oil that brought two million motorists suddenly onto petrol and away from CNG.

Meanwhile, the fuel crisis of June 2020 was blamed by the then government on the sudden collapse of demand when the Covid-19 lockdowns hit, followed by an equally sudden spike in demand once they were lifted, while the price of oil had also dropped, and the government imposed an import ban a month earlier.

And finally, there was the fuel price spike in February 2022 with the onset of the Ukraine war, which the then government tried, in a vain attempt, to hold back from the consumer, but ended up driving up the subsidy bill and delaying the newly started International Monetary Fund program for a second time. That summer, the country was on the brink of default.

Two lessons emerge from these episodes: first, Pakistan’s oil supply chain breaks down when price shocks fail to travel through it smoothly. And second, attempts by the state to manage the price shock only end up creating an even bigger shock that not only fuels inflation, but also destabilises the overall macroeconomy.

In 2007 and 2008, the intercorporate circular debt in the oil sector shot up to nearly $2.5 billion (at prevailing exchange rate) because the beleaguered regime of General Musharraf, keen to shore up its sagging political fortunes, refused to pass on the spiralling cost of oil in international markets to consumers at home. The incoming government after the elections of 2008 eventually settled this circular debt, the only way they could: by printing the money.

The settlement reached in the last quarter of FY2008 to both repay the oil companies and hike fuel prices, propelled inflation to record highs in the months that followed, forced a large and disorderly exchange rate devaluation, and widened the fiscal deficit to 7.4 per cent of GDP from the budgetary target of 4pc. An attempt to try and shield consumers from fuel price hikes ended up subjecting the same consumers to an inflationary spiral — the likes of which they had never seen before.

The same story repeated itself in February 2022, but with slightly different contours. Once again, a beleaguered government keen to shore up its political fortunes rolled out fuel subsidies to shield consumers from an oil price spiral that was roiling international markets following the start of the Ukraine war. The result was a subsidy bill that shot past $1.0bn in three months only.

Once again, the........

© Dawn Prism