JS Global Capital: After touching its 14-year high in March 2022 at $134/bbl, the global oil prices have wiped off all 2022 gains, declining to $75/bbl. The rally was fuelled by surging transport demand post-pandemic lockdowns, the Russian and Ukraine war and production cuts by the OPEC+, leading to CY22, so far, the oil prices to average at $100/bbl, up 45 per cent, compared with the CY21 average.

The ongoing declining trend is being led by multiple reasons. While it started by global monetary tightening, suppressing the demand and strengthening the dollar, nations opting for alternative fuels also curbed partial oil demand.

Moreover, the resurgence of Covid-19 cases in China in the later part of 2022 led to a decline in the economic activity in the world’s largest crude importer and second largest oil consumer. Further pressure on oil prices emerged from higher US oil production, which has reached its highest since the pandemic.

We believe the prospects of improving data points may be a key trigger for the equity markets to perform, unlocking valuations from its forward P/E of 3x. While the prevailing price levels of $75.41/bbl are expected to be realised in Pakistan’s economy with a lag, we discuss the impact on potential data points below.

Consumer Price Index

Lower international oil prices would foremost reduce Pakistan’s transportation costs. The head item alone in the Consumer Price Index (CPI) weighs 6 per cent, in addition to the secondary impact it has on various CPI items.

As the government had already reached the petroleum development levy (PDL) cap on MS, any reduction in ex-refinery prices would give the government room to provide relief to the masses, an opportunity the government may not want to let go in the ongoing inflationary environment. Every Rs50/litre decline in POL product prices (20 per cent of the current base) contributes a 55bps MoM decline in the CPI readings. The impact would further increase with the cost of business declining, as well in a cetri paribus scenario.

Alternatively, the decline in ex-refinery prices would also continue to give room to the government to increase PDL, keeping the retail petroleum product prices steady. This would be over and above our base case, as we already incorporate increasing PDL in HSD at steady ex-refinery prices.

Interest rates Moreover, lower CPI readings may also invite earlier-than-anticipated monetary easing, resulting in some breather in the country’s fiscal account. As interest payment on the domestic debt takes up almost half of the country’s revenue collection, every 100bps decline in the policy rate would result in 40bps contraction in fiscal deficit, as per cent of GDP (annualised).

Current account deficit

Realised imported oil prices in the four months of FY23 averaged at $97/bbl, close to our international oil price assumption for FY23 of $95/bbl. The oil price movement is also crucial to Pakistan’s external account, as the segment contributes 30 per cent to the import bill.

On the trade balance, every $10/bbl would reduce our import bill estimates by $950 million (annualised) or 60bps as per cent of GDP.