Allama Iqbal Open University Islamabad

(Department of Business Administration)

ACKNOWLEDGEMENT

All acclamation to Allah who has empowered and enabled

me to accomplish the task

Successfully first of all I would like to thank our Allah

Almighty who really helps me in every problem during the
project. I would like to express my sincere and humble
gratitude to Almighty who’s Blessings, help and guidance
has been a real source of all my achievements in my life.

I would like to admit that I completed this project due to

parents who pray for my success.

I also wish to express my appreciation to my supervisor

Mr. Waseem who helps me a lot and introduce me to new
dimension of knowledge.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

DEDICATION

My project is dedicated to my beloved Parents,

teachers,

brothers, sister and all of my well wishers.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

TABLE OF CONTENTS

• INTRODUCTION

• Definition
• Classification

• TREND ANALYSIS

• International Oil Prices

• Domestic Prices

• IMPACT ON ECONOMY

• Impact on Exports and Imports

• Impact on Inflation
• Impact on Electricity Price

• AN ANALYSIS OF THE IMPACT OF CRUDE OIL PRICE

INCREASE

• FINDINGS

• PROBLEMS

• ASSUMPTIONS

• RECOMMENDATIONS

• CONCLUSION

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

INTRODUCTION

The high degree of dependence on oil producing countries and any

irregularities in prices and supplies has a pervasive effect for an
economy that imports crude oil to cater to its often fragile industry.
Following the sharp surge in oil prices since 2003, developing countries
that rely heavily on oil imports, are now faced with an increased threat
to macroeconomic instabilities, with Pakistan as no exception.

Definition:-

Petroleum (L. petroleum, from Greek: petra (rock) + Latin: oleum (oil)
or crude oil is a naturally occurring, flammable liquid consisting of a
complex mixture of hydrocarbons of various molecular weights and
other liquid organic compounds, that are found in geologic formations
beneath the Earth's surface. Petroleum is recovered mostly through oil
drilling.

“Mixture of naturally occurring hydrocarbons that is refined

into diesel, gasoline, heating oil, jet fuel, kerosene, and
literally thousands of other products called petrochemicals.
Crude oils are named according to their contents and origins,
and classified according to their per unit weight(specific
gravity). Heavier crudes yield more heat upon burning, but
have lower API gravity and market price in
comparison to light (or sweet) crudes”.

Classification:-

The petroleum industry generally classifies crude oil by the geographic

location it is produced in (e.g. West Texas Intermediate, Brent, or
Oman), its API gravity (an oil industry measure of density), and its
sulfur content. Crude oil may be considered light if it has low density
orheavy if it has high density; and it may be referred to as sweet if it
contains relatively little sulfur or sour if it contains substantial amounts
of sulfur.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

This brief note provides an overview of international oil price trends

witnessed since 2002. Observations are also made on how domestic
furnace and high speed diesel oil price trends move in consonance with
the international oil prices. The need to focus on furnace oil and high
speed diesel oil prices trends arises from the fact that of the total
production by oil refineries of major components of crude oil, diesel
constitutes the highest share of 31% with furnace oil comprising the
second largest share of 29.4% in Pakistan (2006‐07 estimates).1

This study will then focus on how this increasing trend in international
and subsequently domestic furnace and high speed diesel oil prices,
translate into creating imbalances in the economy by exacerbating the
balance of payment crises, worsening current account deficit, soaring
inflation and impacting the rates of other commodities and input
prices. Consequently, the dire need of exploring alternate and
indigenous energy potential perhaps has never been more pressing.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

TREND ANALYSIS

International Oil Prices

The global economy has found itself in the midst of an all time oil price
peak which has also surpassed the peaks experienced during the
Iranian Revolution in 1970s. This surge is having a compounding effect
on the existing macroeconomic challenges for countries whose
domestic economy is consequentially linked with the international oil
market and other product prices.

World oil average prices during 2003‐04 were over 11% higher than
the average prices during 2002‐03. End of the 2004‐05 experienced a
sharp upward swing in prices, with an increase of over 41% compared
to the average price/barrel in the preceding year. Newer peaks were
reported in price/barrel during 2007‐08 when a 53.4% increase in
prices was witnessed, compared to 2006‐07. Overall, there has been a
360% increase in price/barrel of oil since the first quarter of 2002‐03 to
the end of 2007‐08, with the first quarter of 2008‐09 opening into even
higher average prices and etching newer records with prices over
$140/barrel on a given day. Figure 1 graphs the recent trends in world
oil prices.

Figure 1

Source: Energy Information Administration, 2008

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

As evident from the above figure, a rising trend did set in during 2003‐
04. After a temporary fall in prices in the second quarter of 2005‐06
there is a sharp upward swing from the third quarter of 2006‐07 and
onwards. Analysts suggest an interplay of wide‐ranging factors to have
caused this recent upsurge in the world oil prices.

Strong growth of the world economy after 2003 with China and India as
major players, undoubtedly have created exceptional demand for oil. 2
In face of increased demand, supply rigidities not only continue to
persist but are seemingly compounding over time. According to a
recent IMF paper on oil movements and its impact on the global
economy, even with increasing demand‐side pressures, the magnitude
of price increase is most likely resulting from oil supply factors, with
OPEC’s spare capacity diminishing. Additionally, exploitation of
untapped reserves is significantly falling short of global production of
crude oil.

According to the IMF, the supply side rigidities, along with geopolitical
scenario have caused oil supply to become markedly binding, thus
making it extremely vulnerable to even minor disruptions. The fall in
US dollars has also led producers to increase the dollar price in order to
maintain their oil income in terms of stronger currencies like Euro.
Lastly, the off‐late speculative role of investment banks and key oil
market players has also been accused of driving up world oil prices.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

Domestic Prices

Being an importer of oil, the domestic furnace oil prices in Pakistan

follow the rising trend witnessed in international prices.
Figure 2.1

2 The BP Statistical Review of World Energy June 2008, reports a growth of 7.7% in energy consumption by
China. China also accounted for half of global energy consumption growth during 2007. Indian
consumption grew by 6.8%, the third‐largest volumetric increment after China and the US. 3 It takes on an
average 11 years before an oil discovery is ready for production (Elekdag, Selim, Rene Lalonde, Douglas
Laxton, Dirk Muir, and Paolo Presenti. "Oil Price Movements and the Global Economy: A Model‐Based
Assessment." IMF Staff Papers 55 (2008): 297‐311).

Figure 2.1 shows that domestic prices of furnace oil rose by 25%
during 2004‐05 and over 50% by year end 2005‐06. With a slight
deceleration in prices during 2006‐07 (‐1.98%) prices during 2007‐08
posted a record increase of 57.36%. Holistically, it can be observed
that domestic furnace oil prices have been following very closely the
general price trend observed in the international oil market.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

Figure 2.2

A similar analysis of High Speed Diesel Oil (HSD) price trends since
2002‐03 reveals that rises in HSD’s prices have been relatively less
driven by international oil prices. Prices rose by only 7.4%, 16.2%, and
5.28% during 2003‐04, 2004‐05, and 2006‐07, respectively. Prices rose
sharply only during 2005‐06 by 38.15% and during the last quarter of
2007‐08 by 22%. The reason why HSD did not closely follow
international price trends was due to the fact that the government has
been giving subsidy on diesel to reduce the impact of soaring oil prices
on common man as majority of transport fleet in Pakistan consumes
diesel.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

IMPACT ON ECONOMY (BALANCE OF PAYMENTS)

The impact of high oil price in international market has reverberated

well into Pakistan’s economy and has exacerbated the already existing
imbalances. The effect of increase in international oil prices remained
relatively limited until early 2003‐04. This was due to favorable global
conditions, sustainable level of world prices to domestic consumers,
and increase in capital inflow especially remittances. Furthermore, this
can also be attributed to the increase in international oil prices, which
was gradual.

The recent sharp increase, however, severed through the balance of

payments in Pakistan, creating a substantial gap between exports and
imports (Figure 3).
Figure 3

Impact on Exports and Imports

Exports have increased by only 72% since 2002‐03, whereas imports

have increased by 227%. This widening gap has caused the current
account to persistently report a deficit, which is growing at alarming
levels. By the end of 2007‐08, total imports stood at around $40 billion;
more than twice that of exports. The acceleration seen in imports is
largely being driven by the surge in international oil prices and the fact

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

that Pakistan is heavily dependent on oil imports. This is further

substantiated by Figure 4, which shows that the oil

import bill constitutes over 35% of the total import value during the
last quarter of 2007‐8 compared to 25% in the preceding quarter. This
share has increased drastically when compared to the share of 15% in
early 2003‐04. This, along with pressure from increased food prices
has constantly come at a cost of shrinking shares on other items such
as Machinery and Agricultural & Other chemicals.
Figure 4

This certainly has had a negative impact not only on the BOP but also
poses as a threat to the level of industrialization and technological
improvements to the manufacturing sector which then translates into
deteriorating exports. Imports of textile machinery have witnessed a
negative growth rate of 17% and 36 % during 2005‐06 and 2006‐07,
respectively. Similarly, large‐scale manufacturing growth too has
experienced a slump with recording only 4.8% growth during 2007‐08
as opposed to 8.6% during 2006‐ 07. 4
Fiscal imbalances have also been created by GoP’s continued policy of
providing subsidy on oil products to protect poor households and the
domestic industry. The burden of subsidies in face of ever increasing
international prices rise, along with the depreciation of the rupee
against the dollar and the debt service burden is adding to the
pressure on government budgets and increasing political and social
tensions.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

Impact on Inflation

Higher oil prices directly lead to increase in food prices. As a result

there was a substantial increase in head line inflation. The recent need
to import food items like wheat, sugar etc, and depreciation of
Pakistani rupee further led to an increase in food prices. Due to
increase in global oil prices and import bill of food group, headline
inflation is constantly going upwards. The impact of inflation would
have been even worse, had the government not offered subsidies on
oil products and food commodities. Figure 5 shows the inflation
experienced in food prices since 2002‐03 in major groups.
Figure 5

Similar to other developing countries (Ethiopia, Sri Lanka and Ukraine),

Pakistan too faced inflationary impact of rising food and oil prices
which is likely to be amplified by continuing demand pressures. Other
than increase in oil prices, the surges in food prices is due to
withdrawal or reduction of subsidy on food as existing subsidy became
too costly for the government.

Soaring oil prices with increased food prices in evidently have a

negative impact on growth and drive up the cost of inputs. Both these

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

factors are posing a great challenge to the macroeconomic situation of

Pakistan. Faced with such a situation, the low‐income households find
it very difficult to protect themselves against inflation, especially those
living in urban areas.

Impact on Electricity Price

Presently, around 30% of the country’s installed generation capacity is

based on furnace oil. It is high time now that the country should review
its energy mix and start making genuine progress for utilizing alternate
energy sources like wind and solar and for enhancing the share of
hydel, as continued high reliance on furnace oil is becoming more and
more expensive. To date, GoP has been giving subsidy to utilities for
not passing on the impact of high fuel prices to customers. However,
since the budget deficit has now gone beyond sustainable limits, the
government is now moving away from subsidy and utilities are now
being asked to pass on the impact of fuel prices to the customers.
Recently, NEPRA has approved an increase in electricity price up to
60% for distribution companies, which will be implemented shortly.
Since electricity is one of the major components of manufacturing cost,
this will not only increase the CPI further but would also hurt the
competitiveness of our exports.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

An Analysis of the Impact of Crude Oil Price Increase

Findings

• The recent waves of oil price increases have profound effects on

virtually
all industries. Crude oil prices have risen to a record high, and
resulted in price increases for basic commodities and services.

• Economic theorists and business analysts figured that the

soaring oil prices which grow by over 50% from 2004 will
negatively influence the world economy. According to Hong Kong
Trade Development Council, this is because oil prices remain to
be a significant indicator of global economic performance.

• As such, oil prices that are determined by supply, demand and

speculation as well as taxes will affect the consumers and
companies on material and psychosomatic levels.

• The petroleum industry classifies crude oil based on its

geographic location where it is produced and its sulfur content.
Crude may be considered light or heavy depending on density; or
may be referred as sweet or sour based on its sulfur substance.

• In lieu with this, light and sweet kind of oil is preferred since it is
easier and cheaper to refine. Nonetheless, the crude oil supply is
highly dependent on world oil-exporting nations, collectively
known as Organization of the Petroleum Exporting Countries
(OPEC).

• Prior to the actual price increase, crude oil passes through a

supply chain and value proposition strategies that contributes to
the price and its eventual increase or dwindling.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

Problems

The study intends to investigate the effects of run-up in crude oil prices
in Pakistan. Specifically, the study is set to answer the following
questions:

1) How crude oil prices are determined? Why are global oil prices
high?

2) Why are gas prices across the countries different? What are the
factors that affect gas pricing in different countries?

3) What are the influences of OPEC in determining gas prices in

Pakistan?

4) How dependent is Pakistan to oil-exporting nations? How

responsive are Pakistani markets to changes in international
crude oil prices?

5) How crude oil prices increase affect the economic performance

of Pakistan? How the price increases affect the consumers,
GDP and employment in Pakistan?

Assumptions:

• Tax policy plays an important role in determining prices of crude

oil in Pakistan.

• GDP, consumerism and employment is highly volatile with

respect to the movement in international crude oil prices.

• The demand of crude oil in Pakistani is very high, making the Pakistani
petroleum market as highly-dependent to oil-exporting states.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

Recommendations

• The research will adopt a positive view wherein the researcher

prefers to work with an observable social reality in order to come
up with law-like generalizations similar to those produced by the
physical and natural scientists. Also, the study opt for a
deductive approach which will follow the sequence of deducing a
hypothesis; expressing the hypothesis in operational terms;
testing this operational hypothesis; examining the specific
outcome of the inquiry to either confirm the theory or indicate
the need for its modification; and finally, modifying the theory in
the light of the findings (if necessary).

• In addition, the research design for this study will also focus on a
multi-method research strategy using semi-structured interviews
and the survey methods of research. A multi-method research
strategy will be useful for this study because the methods will
allowed the researcher to gain more in-depth understanding of
the phenomenon of the impact of international crude oil price
increases to country-specific increase on oil prices and the uses
of these methods for data collection within one study will ensure
that data are clear, valid and reliable.

• This research would employ telephone interviews which allow the

researcher to have a contact to participants with whom it would be
impractical to conduct an interview on a face to face basis because
of the distance and restraining costs involved and time required to
conduct the interview. Data gathered using these instruments will
be collated for analysis. Data analysis will primarily be
characterized by comparative and statistical approach.
Afterwards, the researcher will summarize all the information,
make a conclusion based on the hypotheses posited and
provided insightful recommendations the topic.

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 Allama Iqbal Open University Islamabad
(Department of Business Administration)

CONCLUSION

• Oil prices and its fluctuations continue to pose as a consequential

macroeconomic concern for both developed and developing
countries.

• For oil importing countries like Pakistan the impact of irregular

and unexpected price hikes quickly seeps into the domestic
economy, threatening the already existing macroeconomic
imbalances.

• Oil price hikes are aggravating the energy shortage in Pakistan

which is now feeding into increased general prices,
transportation cost, slowing down agricultural and industrial
productivity and aggravated water shortages for the rural
economy.

• This is having an enormous financial impact on our

competitiveness in the external sector, creating record trade and
BOP gaps and depleting our foreign exchange reserves.

• In order to move towards attaining fiscal stability and

sustainability, the need for tilting away from heavy reliance on oil
imports towards alternative energy and fuel options now
becomes increasingly important.

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