Petroleum pricing: Only hard choices remain

The Hormuz situation is heating up again, and so is the pressure on Pakistan’s petroleum pricing. After a relatively uneventful spell since the return to daily pricing, the last few days have been anything but calm. Crude has moved back towards the USD100 per barrel mark, while end-product prices have posted double-digit increases on several days, with some unusually long upward streaks. The pressure at the pump is building fast. The return to daily pricing was supposed to make precisely this sort of volatility more manageable. With the formula based on a seven-day rolling average, sharp movements in international prices are naturally smoothed out. But when the underlying market moves hard and fast for several consecutive days, even a rolling average can only do so much. Eventually, the arithmetic catches up. And that is where things get interesting. The rumour mill has already started. One proposal doing the rounds is to reduce the HSD pricing benchmark back towards USD30 per barrel, ostensibly to contain the domestic price impact. Refineries have understandably pushed back. Islamabad, meanwhile, has remained tight-lipped. For now, it remains exactly that: a rumour. But given the precedent, it would be unwise to dismiss any possibility outright. The bigger constraint, however, may lie elsewhere: taxation. The combined petroleum levy and Climate Support Levy currently amount to Rs85 per litre on both petrol and HSD. At a time when international prices are rising sharply, the natural political response would be to cut the levy and absorb some of the increase. But the fiscal and programme constraints make that far from straightforward. Pakistan has already had this conversation with the IMF, and previous episodes have not ended particularly well. With IMF representatives currently in Islamabad ahead of a programme review, reducing hydrocarbon-related taxation would hardly be a comfortable move. The complication is even greater given Pakistan’s commitments under the Resilience and Sustainability Facility, which are explicitly linked to climate policy and the gradual strengthening of incentives against fossil-fuel consumption. In other words, Islamabad cannot have its cake and eat it too. It cannot simultaneously commit to stronger fossil-fuel taxation under the RSF and then routinely dismantle those taxes whenever international oil prices rise. That leaves another familiar option: keep the levy intact and introduce a price differential claim, effectively recreating a subsidy through the Petroleum Differential Claim mechanism. Pakistan has done this before, including during the 2022 oil-price shock and more recently at the beginning of the current conflict. But that is hardly a solution either. A blanket petroleum subsidy is fiscally expensive, poorly targeted and ultimately benefits every consumer, regardless of their ability to pay. Ideally, the government should allow international prices to pass through and use the fiscal space to support the most vulnerable directly. The problem is that Pakistan does not currently have an efficient mechanism for targeting petroleum support according to actual fuel consumption. BISP can provide cash support to vulnerable households, but that is not the same thing as a targeted fuel subsidy, and there is no obvious mechanism through which the two can be neatly linked. So, Islamabad is left with three imperfect choices. Let the full international price shock pass through to consumers. Cut petroleum taxes and undermine the fiscal and climate commitments already made. Or keep the taxes and absorb the difference through a subsidy. None is particularly attractive. Perhaps this is the inevitable consequence of having made petroleum taxation such an important pillar of fiscal architecture. When one sector is expected to deliver so much revenue, policy flexibility during a commodity shock becomes severely constrained. The very tax that helps plug the fiscal hole in normal times becomes politically and economically difficult to defend when the underlying commodity price surges. It is a reminder that fiscal consolidation is not simply about raising another billion dollars wherever it can be found. Every additional revenue measure change incentive creates future constraints and can become a liability when circumstances reverse. The RSF is a case in point. Securing additional external financing was understandably attractive when Pakistan was looking for every possible dollar. But the associated commitments also narrow the policy space precisely when the country needs it most. That does not make the facility a mistake. It does, however, underline why the longer-term costs and constraints attached to incremental financing cannot be ignored in the pursuit of immediate liquidity. For now, something has to give. The government may yet find a technical adjustment somewhere in the pricing formula, international prices may retreat, or perhaps there is a TACO around the corner. But relying on any of these would hardly constitute a pricing strategy. The cleaner solution remains the same: let prices move with the market and reserve fiscal support for those who genuinely need it. Until Pakistan develops a mechanism capable of doing that efficiently, however, every major oil shock will leave Islamabad facing the same uncomfortable choice: hurt consumers, hurt the fiscal position, or hurt the credibility of commitments already made. The current episode may soon force that choice into the open.

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