The political economy of LNG imports

THE petroleum minister has described as a game changer an initiative to import Liquefied Natural Gas to fuel cars with CNG. Under the proposal the CNG pump operators can set up one or more special purpose vehicles (SPV) to import LNG, which would be re-gasified on arrival at the Port Qasim terminal facility presently under construction. It will then be piped to CNG stations countrywide through the leaky pipelines’ infrastructure of the two gas utility companies.

The minister has claimed this would shave $2.5 billion off the oil import bill, make available a 35pc cheaper fuel for consumers and also save the sagging CNG industry.

That the initiative also proposes to exempt LNG imports from GST and the gas infrastructure development cess (GIDC) suggests that the rate differential between the landed costs of crude oil and LNG may not be very much. That in fact if these are applied, it may squeeze the profit margins of the CNG pump operators down to the bone. This also potentially belies the $2.5bn saving claim.

This is akin to providing a subsidy to a scheme that may not otherwise be viable. The petroleum ministry’s argument that the imported LNG would free up gas that the CNG sector presently receives and this would then be diverted to the textile sector and independent power producers (IPP) where it would continue to yield taxes and the cess is fallacious and a distortion of competition.

While the measure may simultaneously placate PML-N’s traditional constituencies — the textile lobby, IPP owners, CNG station owners and millions of vehicle owners — it violates the principle of neutrality of broad-based taxation. The principle states that GST is a tax on consumption, irrespective of the product being consumed, and is to be paid by the final consumer.

Similarly the cess is meant to be used on developing future gas infrastructure and it makes little sense to exempt LNG because at some stage, if demand picks up, more pipeline capacity would need to be built.

At least transparency and national accounting practices would be better served if the government were to levy the tax and cess with one hand and with the other give a direct cash subsidy to vehicle drivers buying CNG at the stations.

So why have the CNG pump operators, with their SPV and the best of intentions, been unable to make this scheme commercially viable? To comprehend this we need to understand that the international LNG trade is carried on between a closed club, where the buyers and sellers are blue chip entities with A or AA credit ratings. As such, entities with lower ratings should expect to receive less favourable terms.

There are 19 exporting countries, Qatar accounting for a third of global production; and 25 importing countries led by Japan, South Korea and Europe. A limited 400 special LNG tankers ply cargo, spanning the globe from Alaska to Australia, the typical cargo value being $200 million. Among these, smaller size vessels of cargo worth $30m to $80m are also available but buying in smaller lots pushes up the landed cost per unit.

Vessel charter rates are also highly volatile. A good part of the cost in this business is in the supply chain and the handling. Importantly, Qatar with its predisposition for larger cargoes, would mean the SPV will have to pick up cargo from more distant destinations which would further drive up its per unit landed cost.

Even once it arrives, a further 10pc of the gas will be lost (and become part of the unaccounted for gas losses) during distribution. The final price at the CNG pumps, including profit, may well be only a fraction lower than petrol — hence the proposal to exempt it from GST and cess.

A better option may be to capacitate PSO, the country’s largest fuel importer, to handle LNG imports. PSO has a more robust financial position than any SPV the CNG pump operators will be able to come up with. It also has better experience of negotiating contracts, procurement procedures and can source much better deals. PSO will be able to achieve an economies effect and land the product at lower per unit prices.

It makes more sense for PSO to spin off a division to handle LNG requirements of all industrial sectors than for individual sectors to go it alone. The petroleum ministry must ask PSO to conduct a feasibility study on the opportunity.

Utmost, of course, systemic gas losses need to be plugged before piping expensive gas into it. This issue should be addressed head on rather than glossing over it by extending tax subsidies and distorting markets.

2014 – Dawn Media Group

Restructuring PIA

PAKISTAN’S national airline lost Rs33 billion last year. This is more than what a fully loaded Boeing 777 would cost.

Few who know the airline business would have expected PIA to make a profit last year. Since the start of the financial crisis in 2008 the global airline industry has been hit by a double whammy.

It has seen a cut in business travel and a drop in leisure travel. On the other hand, high crude oil prices have squeezed yields.

That said; one cannot let PIA off the hook. This is for two reasons. First it has not adequately taken advantage of market opportunities available to it and second, it has let its costs creep well beyond global industry benchmarks.

On the market opportunities front, we have a significant Pakistani diaspora in North America and in Europe. This represents an alluring, captive market that would be the envy of any legacy national carrier. Western airlines typically do not fly to Pakistan.

All PIA has to do is operate direct flights from North American and European cities into major Pakistani cities offering the proposition “fastest way to get you there”. The two main ingredients of this proposition would be affordable fares and on-time performance.

Sadly though, PIA has conceded two thirds of this market to other (mostly Gulf-based) carriers. Financially, this corresponds to Rs60bn in annual revenue that PIA’s competitors have taken away.

Even if half of this can be won back over three years then the airline is looking at a 9pc annual growth rate at a time when most other airlines are stagnant. And this is just on the back of business regained in one segment: the Western hemisphere.

Now to be fair to PIA, the Gulf airlines (and airports) are driven by more than commercial considerations. They are in fact strategic play pieces, part of a larger vision to position these countries as world destinations and to build their image and global profile. This is not unlike the motivation for which countries host the Olympic Games.

It can be argued therefore that PIA is often up against competition of a variety that goes beyond the commercial and profit motive. Still it must cherry pick, then focus on and build its star routes, anchored in the proposition “fastest way to get you there”.

In these markets, traditional marketing has given way to search engine marketing, using which customers search flights, obtain fares and compare routings and timings.

Digital media has opened up new customer touch points which include price comparison websites and social media. It is not uncommon, for example, for customers to be engaging with the airline on Twitter — in real time — discussing meal options on a specific flight.

In addition most airlines have launched their own mobile apps allowing their customers to book tickets, to check-in and to manage their frequent flier accounts from their mobile phones.

Similarly, the domestic market from which PIA derives half its revenue is clearly underserved. The domestic travellers seek convenient flight times and on-time performance. Then there is a segment seeking budget fares.

Service propositions can be developed around these needs and have existed in the past. And while the global airline industry may be facing overcapacity, for PIA there is latent demand in the domestic sector offering several years of growth opportunity. The other main segments are outbound travel from Pakistan for business and for leisure. Here the in-flight experience and holiday airfares are important ingredients of the customer proposition. Then there is the religious travel segment and finally the expatriate Pakistanis in the Gulf region who are time poor and baggage heavy.

It doesn’t make sense to increase market share when each flight is losing you money.

This brings us to the second issue: costs creeping beyond industry benchmarks.

While much is made of overstaffing, in fact PIA’s cost inefficiencies are in its fleet, that last year guzzled Rs61bn worth of fuel. This represents 55pc of total revenue. In terms of the global airline industry, fuel makes up 35pc of total costs.

Meanwhile Australia’s Qantas — perhaps because of carbon tax considerations — keeps it as low as 28pc. PIA’s 55pc is therefore hard to accept.

In addition PIA’s load factor at 70pc is below par. Lastly, the fleet downtime is high with aircraft kept on the ground for want of spares or payment for fuel.

From the perspective of a strategic operating plan, an airline’s business analysis does not begin with aircraft but with the market forecast. However, once the traffic estimates are ascertained, then the most optimal aircraft solutions are found.

If it turns out that the aircraft available from within the airline’s fleet are a poor fit with requirements then a fleet restructuring may become necessary. Alternately it may become necessary for reasons of fuel efficiency or aircraft obsolescence.

If this turns out to be the case then the management and the airline board would need to be given a free hand to take the necessary decisions without outside meddling or interference.

They must also be allowed to choose between buying and leasing the aircraft and to evaluate and decide on the most viable financing plan. Needless to say, a onetime bailout may be extended against a sound business plan so that the airline is recapitalised and these ratios can be fixed.

The other 45pc of the expenses are non-fuel expenses. Whilst drastic reductions in manpower expenses may be unrealistic, airlines around the world have taken fiscal cost control measures which have included contract renegotiations, process improvements and restructuring agent commissions. But if over half of my expense is fuel, then half the time of my management looking for cost savings should be spent here.

Copyright © 2013 – Dawn Media Group