Abstract

The aim of this paper is to understand the effects of the rising Price of Oil, and its consequences for the Developing world. Escalating prices of this precious commodity has led to devastating effects across the globe, but the severity of its consequences is most prevalent in the emerging markets arena. The longest growth spurt in the history of Pakistan has paved the way for the severest recession the nation has ever experienced. High oil prices, political turmoil, and high levels of inflation are all leading to an era of economic uncertainty. The Macroeconomic effects of the Rising oil prices have affected the nation with great intensity. The lasting solution to the problem of imported oil for Pakistan is rapid development of alternative energy. Pakistan is already a pioneer in the use of Natural Gas as a primary source of energy, and further development will only lead the nation towards energy independence.

Key Words; Oil Prices, Inflation, Consumption, Trade Deficit, Economic Growth, CNG.

Outline

1. Introduction

1.1 The Global reaction to rising Oil Prices

1.2 Oil Prices hit the Emerging Markets

1.3 Introduction to the Economy of Pakistan

2. Review of Literature & Empirical Analysis

2.1 High Oil Prices and Economic Growth

2.1.a. Macroeconomic Issues

2.1.b. Monetary Policy for an Inflationary environment.

2.2 The Dynamics of the Current Economic problems of Pakistan

2.3 Oil Prices and Inflation & Oil prices and Trade Deficit-Introduction to the Macroeconomic Model

3. Data Modeling & Empirical Analysis

3.1 Oil Prices and Inflation & Oil prices and Trade Deficit

3.2 Oil prices and substitution with Natural Gas.

4. Empirical Results

4.1 Price of Oil and National Income Accounting

4.1.a Rising Value of Imports

4.1.b Rising Inflation

4.2 Real Affect of Rising Oil Prices on Pakistan .

4.3 Natural Gas as a Solution

4.3.a The CNG Sector

4.3.b The Independent Power Producers (IPP)

4.4 The disadvantage of substituting Fossil Fuels

4.5 Price of Oil and the Demand for Natural Gas, introduction to the model.

4.6 Price of Oil and the Demand for Natural Gas, model tested.

5. Conclusion

6. Bibliography

1. Introduction

1.1 The Global reaction to rising Oil Prices

After hitting fresh records almost every day prior to July/18/2008, the price of oil has fallen, but not enough to ease the growing global epidemic of inflation that high oil prices have brought. The world today is more dependent on oil as a source of energy than it ever was before. This is not the first time global economic leaders are facing the issue of higher energy prices, and rising rates of inflation, but it is still creating a wave of uncertainty, which has negatively impacted all major financial markets of the world. The health of the financial markets is a good predictor of where the economy is headed. Today most bourses around the world have shown double digit declines in market capitalization. Economic Leaders in both, the developed world, and the emerging markets are cracking their heads trying to figure out how to ease the pain their citizens are facing due to the rising prices of energy. Higher energy costs are leading to inflation, as all goods and services require some measure of energy to product, store, and distribute. Higher energy prices are also lessening the discretionary incomes of consumers as they need to spend more on energy leaving less available to spend on other goods and services, therefore negatively impacting consumer spending. As consumers spend less on consumption they decrease the aggregate level of consumption in an economy, which impacts total Gross Domestic Product (GDP) negatively.

What is causing this rapid increase in the prices of crude oil? There are many theories out there trying to explain this phenomenon. One major term is the rapid increase in demand from the rising “BRIC” (Brazil, Russia, India, and China) nations. Rapid Industrialization, and economic growth has prompted the BRIC economies to require a substantial increase in the amount of oil used for energy. The other theory out there is that the depreciating dollar is making it cheaper for BRIC’s, and other nations, to buy more and more oil, because crude is quoted in dollars, and a depreciating dollar is leading an increase in the buying power from domestic currencies. We also hear that increased speculation in the derivatives markets, has transformed this conventional hedging marketplace into a gambling arena, where speculators use margin accounts to buy futures contracts of crude oil hoping to make a profit and sell before contract maturity. The speculators can manipulate oil prices by buying or selling many contracts simultaneously creating greater market volatility. It cannot be certain which one of these variables is most effectively changing the price of crude oil each day, but for now the consequences of this run up from $27 per barrel in 2003, to over $140 per barrel in 2008, has a very sour outlook for the global economy.

Why does the price of Oil effect the growth of the global economy? The main reason is that a large amount of oil reserves that remain today are located in areas where the consumption is low due to lower populations (the Middle East, and northern Europe). This makes the more populated nations net importers of oil, and increased prices leads to increased import bills, which affect a host of other macroeconomic fundamentals of oil-importing nations’ economies.

Source: ReutersQ-Charts

1.2 Oil Prices hit the Emerging Markets

The effects of the rising price of oil and its negative externalities can most notably be seen in the current severe economic slowdown in some parts of the developing world. The developing nations historically have been a place where economic growth has remained robust even in the most uncertain of times. Today the picture looks much different as rising costs of energy is leading to higher production costs, and higher transportation costs for all goods and services in the economy. Producer price indexes (PPI), measures the change in prices that producers face as a as a result of rising costs, and because of rising oil prices many nations have steeply increasing PPI’s. Producers pass down part of their rising costs to the consumers, which increase the shelf price of goods and services driving up the index of consumer prices (CPI). Inflation is not the only concern facing policymakers in the emerging markets, because most of the oil these growing economies use is imported, the rise in the price is leading to hefty import bills contributing to rising trade deficits. Trade deficits are not necessarily a negative outcome, but a growing trade deficit can lead to more macroeconomic issues in the long run.

The biggest problem with rising prices of imported oil is that prices are rising at a rate at which none of the central banks across the world expected, and this is adding the huge amounts of money on every nations import bill. Unexpected inflation, due to the rise in costs of production, and transportation because of the rise in energy costs- primarily imported oil- leads to imported inflation in the domestic markets. In countries where the elasticity of demand for imported oil is relatively inelastic (i.e. 0<d<1) there is a greater effect on the macroeconomic stability of that economy. Economies that are most affected by this run in oil prices are ones where the percentage of GDP spent on imported oil is higher than that of other nations where the percentage of GDP spent on imported oil is lower. The percentage of Gross Domestic Product (GDP) spent on imports, and more specifically on oil imports, varies drastically. Well developed industrialized nations tend to have a higher nominal GDP corresponding to a

lower percentage of that spent on imports. Countries where the nominal GDP is very low, a greater percentage of that national income is spent on imported oil, given similar population demographics, all other things the same.

1.3 Introduction to the Economy of Pakistan

Pakistan is amongst the major developing economies of the world. With a population of over 150 million, it is also one of the most populous countries in the world. Pakistan is a major trading partner to all developed nations of the world, including the U.S., U.K., France, Germany, U.A.E., and Saudi Arabia. Political uncertainty, social issues, and corrupt governance have delayed steady economic growth in the 61 years of Pakistan’s existence. This has not necessarily been the case for the past 7 years- as the following indicators suggest- a prosperous economic future was in sight, but the current global dilemma of increasing oil prices has turned the tables quickly.

The economy of Pakistan has experienced some unprecedented levels of economic growth in the past 6 years. The growth has remained above 6% per annum Year over Year (YoY) since 2003 to 2007. The foreign workers’ remittances have grown at an exponential rate, showing signs of confidence in the economy, by Pakistani expatriates. Inward foreign investment both Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) have grown substantially. The foreign exchange reserves have steadily grown from $2 Billion in 2001, to over $14.5 billion1 in 2007. Pakistan’s largest stock exchange index, Karachi Stock Exchange-100 Index (KSE-100) has steadily grown from 890 points in 1998, to over 15,0002

points ( Jan-2008). Inflation has stood steady at approximately 9% per annum from 2000-2007. All of these factors combined have fueled the largest ever economic expansion in Pakistan’s history.

The picture is not as perfect as it seems, because all these numbers show the growth rate till the end of 2007. This year the scenario is much different. The economic growth rate has slid into negative territory in real terms. Inflation has risen to double digits, and the trade deficit has steadily risen to the highest level in Pakistan’s history. High oil prices have led the government to reset the subsidies on oil that the previous administration had levied. This has led to an increase in the retail prices of petroleum products by over 49% since Jan/2008. The increased prices have translated into higher prices in the broad economy. The Average (YoY) CPI has jumped up to 17%. The largest increase within the CPI was the increase in prices of food and energy, which have risen by 34.91% and 24.51% respectively. The rupee has depreciated versus the US Dollar by more than 14% since Jan-2008, leading to a capital flight, as more and more investors pull money out of the Pakistani economy, fearing further deterioration of the financial stability. The KSE-100 index has slid from a high of over 15,000 points, to a low of 10,000 points (Jun-2008).

What consequences do rising prices of oil fueling economic instability have on the economic future of Pakistan? First, this rise in oil prices is leading to huge increase in the PPI, and CPI, leading to higher levels of inflation. Second the rising trade deficit is growing and adding to an already hefty import bill

1 Federal Bureau of Statistics www.statpak.gov.pk2 Karachi Stock Exchange www.kse.com.pk

which is being financed by national exchequer. The current trade deficit is greater than 12% of total GDP.

Introduction to the Alternative to oil in Pakistan: Natural Gas

There is one positive result of the rising price of oil; the rapid development of alternative sources of energy. The rising price of oil has prompted the government to launch many initiatives on the development of alternative energy, but the most successful of these has been Compressed Natural Gas (CNG). Pakistan has become one of the largest users of Natural Gas a primary energy resource. In addition to the rising consumption of Natural Gas in the industrial, commercial, and agricultural sectors, Pakistan has now become home to the world’s largest fleet of Natural Gas Vehicles (NGV). The transportation sector has seen exponential growth in Natural Gas consumption, as the number of CNG powered vehicles has risen from less than 10,000 in 2002, to over 1,500,000 by 2007. The number of Compressed Natural Gas filling stations has also increased exponentially from less than 20 in 2001, to over 1,500 in 2007. Independent Power Producers, which provide 35% of total energy to all other sectors of the economy, are swiftly shifting their oil based power generators to natural gas based generators to ease the burden of rising oil prices on the economy.

Why does Natural Gas seem to be a better option to substitute one fossil fuel with another? The most simple and obvious argument would suffice for this scenario; natural gas is cheaper than crude oil in the World markets, there is a substantial amount of supply available in Pakistan eliminating the need for importing energy raw material, and it is cleaner for the environment.

2. Review of Literature & Empirical Analysis

2.1 High Oil Prices and Economic Growth

2.1.a. Macroeconomic Issues

The energy sector of Pakistan is comprised of a unique mix of resources. In my review of the literature for this research, I came across these facts regarding the energy sector in Pakistan and its sensitivity to the rising prices of crude oil. According to Malik (2008), the growth in demand for petroleum products in Pakistan has been growing at a negative rate. The current volume of imported oil has been steadily increasing at a negative rate, but the dramatic increase in the price of oil has led the value of those imports to rise exponentially. The study further shows that as the rise in the price of oil started in early 2003, Pakistan’s economy steadily grew at a rate of over 6%. This negates the conventional direction of the economic growth when price of oil rises. An upward trend in the price of oil usually squeezes income, and demand, Leading to less consumption, and lower corporate earnings, leading to lower economic growth. The scenario of rising oil prices, and economic growth were fueled by the monetary expansion that took place in most nations across the world between 2002 and 2006.

The following illustration shows the negative impact when the monetary expansion measures had cooled down (2006-present), squeezing the amount of money in circulation; the GDP growth rate slid. Beginning in 2005, the economic growth rate has grown at a decreasing rate, citing the effects of the rise in prices of imported oil as a primary cause.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Rising prices of imported oil have increased the amount of foreign exchange reserves required to finance the purchase of the oil. As the price goes up, the foreign exchange reserves go down, and the value of debits rise on the current account of the nation’s trade balance, leading to a trade deficit. A very large trade deficit can cause the value of the domestic currency to drop as a measure to increase the competitiveness of local exporters to offset the growing trade deficit. Depreciation in the local currency has its own negative effects, as it results in lower returns, and net capital outflows, as investing in a country where the currency is falling in value leads to higher foreign exchange risks. Lower capital means lower investment spending, thus weakening the local economy further.

2.1.b. Monetary Policy for an Inflationary environment.

In a study by Khan and Schimmelpfennig (2005), the correlation between an expansionary monetary policy and rising inflation are very strong. Meaning if the government tries to expand the money supply it will surely meet inflation as a primary consequence. The significance of this study for our purposes is that in the period preceding the current oil price crisis, we had the largest credit expansion all over the globe. The economy of Pakistan experienced an average of a 22% increase in broad money and 30% increase in credit growth between 2004 and 2006. Although expansionary monetary policy does aid inflation, the effects of a growing money supply between 2004- 2006 have been minimal in raising inflationary pressures in Pakistan. As the following illustration suggests, expansionary monetary policy had been implanted as early as 2002, but CPI did not start rising till as late as early 2008. This picture looks very similar to the illustration depicting the rise in the price of oil. Beginning 2007, the rise in the price of oil resulted in higher inflation rates in Pakistan.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

2.2 The Dynamics of the Current Economic problems of Pakistan

Looking at the table below, the industrial sector and the transportation sector are the two largest components of total energy consumption in Pakistan. A rise in the Price of Oil, by 100%, led to an increase in demand for oil by 19% over the period between 2003 and 2007. This denotes a low price elasticity – the percent change in quantity demanded/consumed, divided by the percent change in price- meaning the demand for oil in Pakistan is relatively inelastic to changes in Price.

Price Elasticity = 19%/100%= .19 ; Relatively inelastic.

Change in Oil Consumption with Change in Price

2003-2004 2006-2007 Change Percent Change

Oil Consumption(TOE) 15,221,024 18,120,837 +2,899,813 +19%

Price of Oil ($)(annual average)

$32.00 $64.00 +$32.00 +100%

Source: Hydrocarbon Development Institute of Pakistan.

Total Energy Consumption by Sector (metric Tonne)

Total Energy Consumption by Sector (metric Tonne)

2003-2004 2006-2007 Change Percent Change

Domestic 6,278,918 7,605,145 +1326227 +21.1%

Commercial 851,857 1,377,247 +525390 +61.7%

Industrial 11,098,642 15,792,049 +4693407 +42.3%

Agriculture 734,202 767,266 +33064 +4.5%

Transportation 8,771,365 9,721,183 +949818 +10.8%

Total 27,734,984 35,262,891 +7527907 +27.1%Source: Hydrocarbon Development Institute of Pakistan www.hdip.gov.pk

The low price elasticity tells us that as prices rise there is limited or no effect on demand, thereby increasing the Dollar amount of quantity consumed. This means the total effect on the nations import bill consists of the 100% increase in price of oil, in addition to the 19% increase in oil consumed.

Looking at the picture below, the domestic production of oil is very limited in Pakistan, and more than 85% of oil is imported today. This picture shows changes in amount of oil consumed, but the issue here is the price of oil, although the barrels of oil consumed each day have increased at a marginal rate between 2002- and 2006, the price has gone up by more than 100% as shown earlier. The numbers today are even higher (est. 2008). The difference between the consumption and the domestic production of oil is adding to the import bill of Pakistan leading to a growing trade deficit.

The Balance of Payments of Pakistan has shown a growing trade deficit for the past 6 years. Looking at the picture below the trade deficit stood at approximately $5 Billion in 2005, and has grown to over 20 Billion as of 2008. This rise is further deteriorating the macroeconomic fundamentals of the nation.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

2.3 Oil Prices and Inflation & Oil prices and Trade Deficit-Introduction to the Macroeconomic Model

Finally, economic model that explains the effects of rising oil prices on the economy of Pakistan is as follows, as the price of oil goes up, the value of imports rise, causing a negative impact on the trade deficit. The other more significant effect of rising oil prices is increased inflation due to the rise in costs of imported oil, leading to the rise on production, transportation, and all other energy costs faced by producers, and consumers. Higher Consumer Inflation leads to lower discretionary income left with consumers to buy other goods and services which decreases total consumption in an economy leading to slower economic growth. When inflation gets out of control central banks usually tighten the money supply which can contract the economy even further.

The main issue is the effect of rising prices on the national economy and the changes it brings within the economic model. Rising prices of oil are causing increased unanticipated inflation, and lower economic growth hence impacting the economy negatively. This can be shown through a simple macroeconomic model of:

GDP = Y = C + I + G + (x-m) , where

C= consumption, I= investment spending, G= Government Spending, x= exports, and m = imports.

As price of oil goes up, inflation kicks in as price of every item in the basket of goods rises (virtually all items need some form of transportation or storage exposing them to the costs of energy). The increased prices lead to lower discretionary incomes leading to less C (consumption), decreasing the total amount of Y(GDP).

The other effect of rising oil prices is that as oil prices go up, an economy importing majority of its oil, will see a rapid increase in the value of m(imports), leading to an increased trade deficit, hence lowering the trade balance, or creating a trade deficit which will result in lower Y (GDP). Both these cases will be further developed in section 4, using actual statistics.

3. Data Modeling & Empirical Analysis

The data used to prepare this paper, is derived from a variety of sources, including working papers, and Government organizations. The modeling consists of simple use of economic tools to analyze the impact of oil prices on the economy of Pakistan.

The numbers and statistics used all are recent most figures obtained from the State Bank of Pakistan, Federal Bureau of Statistics of Pakistan, Hydrocarbon Development Institute of Pakistan, the IMF, the World Bank, and The Asian Development Bank(ADB). All figures used are at calculated at current price levels, and the percent changes are calculated on a YoY basis.

The methodology used to determine the level of Gross Domestic Product consists of the expenditure model. The whole is divided into 2 sectors according to the official Federal Bureau of Statistics division in Pakistan; Production Sector, and Service Sector.

The Production Sector consists of total expenditure in Agriculture, and Industry. According to the national accounts the Agriculture industry in the production sector includes crops, livestock, fishing, and forestry. The Industrial sub-section within the production sector consists of mining & quarrying, manufacturing , construction, and electricity & gas distribution.

The Service sector includes expenditure in transportation, wholesale & retail trade, finance & insurance, ownership of dwelling, public administration & defense, and community, social & personal services.

4. Empirical Results

4.1 Price of Oil and National Income Accounting

Examination of the analytical model as mentioned above very similar results as to what actually happened in Pakistan during the period when oil prices rose exponentially. To do this, I am going to use the numbers from the following tables showing the GDP (Y) of Pakistan, the total Consumption Expenditure I, Investment (I) & Government Spending (G), and the net Exports (x-m).

GDP at Current Prices (2008)

USD $ (BILLION) 2003 2004 2005 2006 2007 (est.)2008

Consumption( C ) 66.10 78.00 91.85 107.30 120.00 129.78Investment & Government Spending ( I + G ) 13.60 15.58 20.67 27.10 32.35 35.46

Exports ( x ) 10.65 11.25 13.78 15.63 16.05 16.85

Imports ( m ) 11.52 14.29 19.48 27.66 29.50 37.44

Balance of Trade ( x – m ) (.87) (3.04) (5.70) (11.97) (13.45) (20.59)GDP ( Y ) = C+I+G+(x-m) 78.83 90.54 106.82 122.43 138.9 144.65GDP Percent Change(YoY)% - +11.71 +17.9 +14.6 +13.5 +4.1%Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

4.1.a Rising Value of Imports

As you can see, the numbers tell us nothing other than the GDP, at current prices has been steadily growing. The issue arises when we look at the change from one year to the next. For example comparing the balance of trade between 2007 and 2008 shows that the rate at which the trade deficit increased was (20.59-13.45)/13.45 = 53%. Taking any year for example 2007, if we examine the numbers it is: Y=C+I+G+(x-m), so Y= 120+32.35+ (16.05-29.5) = 138.9 ($BILLION) >>**(I+G)=32.35**<<

In 2008 the value of m increased, leading to a negative effect on the growth of Y. Unexpectedly the value of imports rises to 40($BILLION). The GDP rose but a decreasing rate

Y=129.78+35.46+ (16.05-40) = 140.65 ($BILLION) >>**(I+G)=35.46**<<

GDP growth rate fell from 17.9% (YoY) in 2005, to 4.1% (YoY) in 2008 (est.).

Meaning a rise in the value of imports at any given time will result in a fall in the growth rate of Gross Domestic Product, in nominal terms. Assuming oil is predominantly imported in Pakistan, the rise in the price of oil, will increase the value of imports (m) leading to a negative impact on the growth rate of national income(Y).

The other impact of rising prices of imported oil translate into a growing trade deficit which depicted earlier shows the growth of imports much higher than the growth of exports. Examining the table above, exports have grown by 7.8% between 2006 and 2008, while imports have grown by 35.3%.

4.1.b Oil Prices, Inflation, and lower GDP growth.

Increased imported oil prices cause inflation, as the costs of production, storage, and distribution rise (assuming oil is a major source of energy in the economy). Increased inflation lowers the buying power of consumers in addition to lowering discretionary income left (after buying more expensive energy) with households to spend on other goods and services. This leads to lower growth in consumption spending, further weakening the economic outlook of the nation. The following table shows that although total consumption spending has been growing, the (YoY) change in percentage terms is declining in Pakistan. Proving that higher oil prices are leading to lower economic growth, as lower growth in consumption ( C ) means lower growth in GDP ( Y ). In addition to lower consumption growth, higher growth in imports (m), are further deteriorating the situation as shown earlier.

Consumption Spending Growth (2005-2008)

Consumption( C ) US$ in Billions Percent Change2005 91.85 -2006 107.30 +16.8%2007 120.00 +11.8%2008 125.78 +4.8%Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

The CPI data which follows shows the rapid increase in the Consumer Price Index as a direct result of the rising price of oil.

Consumer Price Index (2004-2008)

Consumer Price Index(YoY) Percentage Percentage Change2004 4.57 -2005 9.28 +103%2006 7.92 -14.6%2007 7.77 -1.8%2008 18.29 +135%Source: Federal Bureau of Statistics, Govt. of Pakistan. www.statpak.gov.pk

4.2 Real Negative Affect of Rising Oil Prices on Pakistan.

So the rising price of oil has had 2 major affects on the economy of Pakistan.

Effect 1. Increased value of imports (m), have led to decreased GDP growth rate. Increased prices of imported oil have also brought Inflation which has decreased buying power of money, and increased the energy costs of consumers and producers resulting in lower discretionary spending.

Effect 2. Lower discretionary spending has contributed to the declining rate of consumption grow th th ( C ) lowering GDP growth rate further.

Illustration of Effect 1. And & Effect 2.

Effect 1

Increased Imports have led to the a decreased trade balance or an increased trade deficit as follows. I

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Effect 2

Increased imported energy prices have led to increased prices at home leading to increased inflation. Increased inflation has decreased the discretionary income of households, leading to decreased discretionary spending. Decreased discretionary spending has resulted in slower consumption growth.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Higher Inflation = Lower Consumption Growth as follows:

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

Lower Consumption growth, and higher trade balance result in decreasing economic growth depicted as follows.

Source: Federal Bureau of Statistics, Pakistan www.statpak.gov.pk

4.3 Natural Gas as a Solution

The advantages of Natural Gas as a substitute for Oil are quite apparent in the Pakistani economic framework. The government is offering simple price incentives for the use of Natural Gas as opposed to oil for consumers in the transport industry; mainly private and commercial vehicles. The other incentive is for Independent power producers (IPP) to switch their power production methods from oil powered pants to gas powered plants. IPP’s contribute to about 35% of the nations’ total power production, and about 59% of total non hydroelectric power.

Power Generation by Type of Producer ( MW)

Source: Private Power and Infrastructure Board of Pakistan. www.ppib.gov.pk

The Natural Gas prices are kept low due to the abundance of local supply in the Pakistani markets. The two primary sources of natural gas are The Sui gas field in the western province of Baluchistan, and the Kandkhot Gas Field in Sind. Both these gas field produce over 50% of the total Gas production in the nation. The other 50%consists of more than a dozen small to medium size gas field across the nation. Currently Pakistan does not import natural gas. Domestic production is sufficient to meet the current demands. Rapid investment in the Natural Gas sector has led to an increase in the number of Natural Gas Vehicle’s on the road. This significantly releases the economic burden of buying expensive foreign oil for the transportation sector. Pakistan has over 1.6 million NGV’s which makes it world’s largest fleet of CNG powered vehicles. The benefit for substituting a conventional gasoline powered vehicle with a natural gas vehicle is the simple price advantage that the government has maintained. The current cost of Compressed Natural Gas (CNG) per Gallon of Gasoline Equivalent (GGE) is $1.36 (approximately Rs. 97.76), and the cost of regular gasoline $4.12(approximately Rs. 292.50) per Gallon. The effects of this huge price differential can be seen in the following illustration depicting the change in the consumption of energy by sources. As a percentage of total energy consumption in Pakistan, natural Gas now stands at 48%, and oil is down to 29% of total energy consumption. In 2001, oil consumption contributed to more than 45% of total energy consumption, and gas stood at 33%.

Power Generation 2008Existing Generation  Hydroelectric 6444GENCOs 3580IPPs( Independent Power Producers) 5541Rental 285SPPs 53Total 15903

Total Energy Consumption in Pakistan (sum = 100%)

Source: Ministry of Petroleum and Natural Resources, Pakistan.

The consumption of CNG is on the rise where as the consumption of oil is declining. Coal and Liquid Petroleum Gas (LPG) is also growing at a marginal rate. This represents a permanent shift in dependence on foreign oil by the economy of Pakistan.

4.3.a The CNG Sector

Pakistan has spent more than $1.1Billion in developing CNG sector for the evolution of the transportation industry. The bulk of it is investment was spent on building new CNG filling stations. CNG filling stations are similar to gasoline dispensers, but they require a compressor some place near the dispenser where the natural gas is compressed to form CNG, which is is filled into the CNG cylinders in the vehicles. Manufacturing and distribution of CNG conversion kits are another growth area which has rapidly developed in the past few years to meet the growing demand of individuals converting their gasoline vehicles to CNG. A CNG conversion kit costs between $500 and $700, and can easily be installed in any gasoline powered vehicle in less than 3 hours. After the installation the vehicle is able to run on both gasoline and CNG.

4.3.b The Independent Power Producers (IPP)

IPP’s play an important role in aiding the transformation of Pakistan from an oil powered nation to a Gas powered nation. Most IPP’s use conventional generators that run on oil products such as gasoline, and diesel. The shift lies in investing large amounts of capital to install gas powered generators in order to reduce the nation’s dependence on oil, and increase profitability at the same time. The government is helping speed up the process by offering import incentives on capital machinery such as zero customs duty, and income tax benefits.

4.4 The disadvantage of substituting Fossil Fuels

The downside exists, that local production of Natural Gas is increasing at a declining rate. According to official estimates Pakistan will be a net importer of Natural Gas in the next 10 years in order to meet the increasing gap between supply and demand. The downside is that all commodities seem to be heading higher in today’s markets and it seems inevitable that cheap natural Gas will also become more expensive.

The first advantage of making this shift is that the world still has Natural Gas in Abundance, and according to estimates (by BP world Statistical review) the reserves of Natural Gas are about 6,233 Trillion Cubic Feet. Dividing that number by 127.8 = 48.8Trillion (GGE). That is equivalent to 1.161 Trillion Barrels of Oil.

The advantage Pakistan still has is the fact that it will be amongst the first to demand such large amounts of natural gas, so it can secure its supply, by ensuring deals with governments of nations with abundant natural gas. Iran, and Qatar, both have tremendous amounts of proven natural gas reserves, and Iran is on the verge of completing a deal to build a gas pipeline across Pakistan, to India, offering Gas to Pakistan at discounted rates. Both nations are in close proximity to Pakistan giving the nation a locational advantage to ensure speedy delivery of natural when the nation begins importing.

4.5 Price of Oil and the Demand for Natural Gas, introduction to the model.

The rise in the price of oil has led to expansion in developing natural Gas as a primary source of energy. The methodology used to determine the benefits of substituting imported oil with natural gas as primary source of energy in Pakistan is a very simple deductive economic model of prices. The assumptions here are that the oil and natural gas are easily substitutable. The availability of both resources is equally accessible to most consumers, and the simple difference in prices has led to a substitution by households and producers of oil with natural gas.

As prices of Oil rise demand slows, and supply and all other variables held constant, the quantity demanded falls. At the same time due the lower price in the natural gas market, demand increases and all other things held constant, the entire demand curve shifts to the right. Conventionally this will lead to higher prices of natural gas but to tackle this the government intervenes by offering a subsidy to

suppliers of natural gas to meet the new demand the supply curve also shifts to the right eliminating any excess demand, but keeping equilibrium price constant.

Assuming both oil and gas are normal goods, and are primary energy sources for all three sectors of the economy-namely the industrial sector, the transportation sector, and the commercial & household sector-and has a normal relationship with respect to prices (i.e. as prices go up, demand goes down).

Then they will be perfect substitutes if the rise in price of one, leads to a rise in demand for the other. To examine this hypothetical claim the actual numbers in Pakistan’s energy sector have to be studied.

4.6 Price of Oil and the Demand for Natural Gas, model tested.

Examining the table obtained from the Hydrocarbon Development Institute of Pakistan, the demand for natural gas has shown a steep increase in the years 2003-2008. This increased consumption is the direct result of the rise in the price of oil. Government initiatives in the form of subsidies have aided the increased use of natural gas, but majority of the increased demand comes directly as a result of the increased price of oil.

Change in Price of Oil VS. Change in Gas Consumption

Tonnes of Oil Equiv.(TOE) in million’s

2004 2005 2006 2007 Percent Change (since 2004 in 2007)

Oil Consumption 11.14 11.71 10.87 10.88 -2.3%

Gas Consumption 10.01 11.77 13.40 14.90 +48.8%

Price of Oil ($) $37.66 $50.04 $58.30 $64.20 +70.5%

Source: Hydrocarbon Development Institute of Pakistan. www.hdip.gov.pk

Consumption of Natural Gas has gone from 10.01(million TOE), to 14.90(million TOE), where as oil consumption has dropped from 11.14(million TOE) to 10.88(million TOE). The result clearly shows that an increase in price of oil of 70% from 2004 to 2007, has led to an increase in demand for natural gas by 48.8%, and a decrease in oil consumption by 2.3%. It’s worth noticing that the increase in price did not affect demand for oil by a great amount, but it did affect the demand negatively showing the presence of elasticity even in a product which is relatively inelastic.

Simple conclusion from this example shows the relationship of both natural gas and oil being nearly perfect substitutes to each other

5. Conclusion

From the analysis of the price of oil and its consequences for economic growth in Pakistan, and all over the world, I can conclude that the affects are severely damaging the macroeconomic stability of all economies which are dependent on imported oil.

Pakistan is a good example to show how an increase in the price of a commodity that has a relatively inelastic demand can disrupt the macroeconomic fundamentals, such as the level of inflation, the growth in consumption, and the value of imports, and the trade deficit. A growing Negative impact of these indicators has led to slower economic growth in Pakistan. The major consequences on the economy of Pakistan have been:

Increased value of imports (m), have led to an increased trade deficit, which has resulted in a decreased GDP growth rate. Increased prices of imported oil have also brought Inflation which has decreased buying power of money, and increased the energy costs of consumers and producers resulting in lower discretionary spending. Lower discretionary spending has contributed to the declining rate of consumption growth ( C ) lowering GDP growth rate further.

The positive outcome in Pakistan has been the rapid development of Natural Gas, as an alternative to imported oil. Natural Gas is produced domestically, and this has kept the price of natural gas significantly lower than the price of oil in the Pakistan’s energy markets. NGV’s, and gas powered IPP’s can do much more to transform Pakistan into a nation run exclusively on natural Gas. Other alternatives to Fossil Fuels such as Oil and Natural Gas exist in the form of Solar Power, Wind Power, Bio-Diesel and Geo-Thermal Power, but the capital investment required is very large, and although current oil prices are shifting attention towards the renewable energy marketplace, there is still some time before solid steps are taken to take Pakistan towards complete renewable energy.

6. Bibliography

1.“How Pakistan is Coping with the Challenge of High Oil Prices,” by Afia Malik, Pakistan Institute of Development Economics

2. “Inflation in Pakistan: Money or Wheat,” by Mohsin S. Khan, and Axel Schimmelpfennig, International Monetary Fund

3. “Pakistan’s Macroeconomic adjustment and assumption of growth, 1999-2004,” by Henri Lorie, and Zafar Iqbal, International Monetary Fund

4. “Contribution of Workers’ Remittances to the Economy of Pakistan,” by Zafar Iqal, and Abdus Sattar, Pakistan Institute of Development Economics

5. “Exchange Rate instability and Trade,” by M. Ali Kemal, Pakistan Institute of Development Economics

6. “Interim Monetary Policy Measures,” by State Bank of Pakistan May 2008

7. “Inflation Monitor,” by State Bank of Pakistan May 2008

8. “Pakistan Energy Yearbook,” Hydrocarbon Development Institute of Pakistan 2007