On 1st
June, Pakistan Petroleum Exploration & Production Companies’ Association
(PPEPCA) had requested the government to issue a Rs 500 bn budgetary grant for state-owned enterprises (SOEs) suffering from
circular debt in the gas sector. Its demands were ignored.
Then on July 17th,
PPEPCA wrote
a letter to the
Ministry of Finance (MoF). The letter warned the MoF that the gas sector was on
the verge of financial collapse due to cash flow issues originating from
circular debt.
PPEPCA threatened
to halt exploration activities and reduce gas supply if their demands of
retiring circular debt were not met. This seems to have caught the attention of
MoF, since a few days later the Economic Coordination Committee allowed exploration & production (E&P) firms to pay
sales tax on an installment basis.
But now, it appears
that the IMF wants more action. As per ‘ARY sources’, IMF actually wants the
government to settle some part of the gas circular debt – Rs 415 bn worth. Now,
it’s difficult to say how reliable these sources are; yet the news might be
plausible.
IMF’s Staff Report
– which was released a couple of weeks ago – placed a strong emphasis on
circular debt. It might be possible that the IMF saw complaints and threats from
PPEPCA and decided that some part of the circular debt had to be settled.
But market
participants would remember that this same scenario played itself out back in January
and February 2023. Rumors came out that the MoF was planning to settle Rs 543 bn worth of circular debt, mostly to be paid
to PPL and OGDC – OGDC being the bigger beneficiary.
As a consequence,
PPL and OGDC’s share prices skyrocketed more than 30-40% within a matter of
weeks. But then, the IMF shut down these plans as it wanted the government to
raise gas prices instead of settling circular debt.
Note, the IMF is
not against settlement of circular debt via means of issuing bonds, grants, or
dividends among SOEs. It has allowed this in the past with both the gas and
power sector, most recently back in 2021. However, at the time, it wanted the
government to stop the bleeding or rather, the increase in circular debt first.
Consequently, the
government raised gas prices but didn’t settle any circular debt in February –
just as the IMF asked. PPL and OGDC share prices came tumbling down on that
news.
Many people would,
and have, suggested that this is a classic pump-and-dump. But it’s not. E&P
SOEs are continually trading at distressed values because they have serious
cash flow issues resulting from circular debt. Moreover, the government treats them
as a black hole for subsidizing gas to domestic consumers. But, if any part of
their receivables actualizes into cash flows, that generates a massive impact
for them given their distressed valuations.
To understand
this, let’s assume that PPL and OGDC both receive Rs 100 bn each in cash inflows
due to the gas sector circular debt settlement. PPL and OGDC have 2.7 bn and
4.3 bn shares, respectively. That imputes a free cash flow addition per
share of Rs 37 and Rs 23 for PPL and OGDC, respectively. That is – essentially
– cash which can be distributed to PPL and OGDC shareholders via dividends.
Now, if it’s
confirmed that PPL and OGDC are in fact receiving such amounts, then their
share price must go up and reflect this increase in free cash flow. Hence, it
makes perfect sense for their share prices to go up on the rumors of circular
debt settlement within the gas sector.
But obviously,
right now we do not have such details. It is unclear how much of the circular
debt being cleared will make its way to OGDC, PPL or other SOEs. Additionally, the
probability of this circular debt being settled is hard to estimate too. The
probability of this event happening depends completely on individual investors
– some may be pessimistic, others optimistic.
As a basic formula
for absolute gain in share price of company X, one should use this: (Probability
of event happening) multiplied by (Amount of circular debt being settled for X)
divided by (X’s number of shares). So, let’s say I assign a 50% chance of PPL
receiving Rs 100 bn, then its share price should go up by Rs 18.5 from its
closing price on the last trading day before this news came out – that would be
27th July.
The circular debt may
or may not get settled. It’s a game of probabilities now.
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