Winter Internship (2011) Report by Arif Mustafa Financial Reporting

DEPARTMENT
Financial reporting (MIS)

IMMEDIATE SUPERVISOR:Fahad Muslehuddin Manzoor, ACA Senior Executive Finance MIS

SUPERVISOR:Iftikhar Ahmed Deputy General Manager Financial Reporting & Taxes

PROJECT :Presentation on Circular debt in the energy sector and its resolution (Group work)

TEAM MEMBERS:Soomal Memon ACCA Finalist Raza Ravjani ACCA till date Raza Banani BBA(Finance) 3rd year, ACCA till date (Iqra University) Arif Mustafa BBA (Finance) (SZABIST)

ASSIGNMENT:The project which was assigned to us was the inter-corporate circular debt. It has been the current focus of PSO, because of the increasing amount of trade debts. Trade debts has amounted to Rs 150bn and increasing till date, therefore it has been a major concern for PSO to resolve this issue as now the liquidity status of the company has started coming under pressure.

PROJECT WORKING:The First day, after the project briefing, all group members had meeting on how to go about the project. Our project required a great level of understanding about the current economic situation, financial research on Oil Marketing Companies (OMCs), energy sector profile, Circular debt and its dimensions, Annual Oil Production, Oil Industry sale performance and Financial Reporting. In the meeting we decided to first extract the primary data related to circular debt and its emergence, available on the internet.

Winter Internship (2011) Report by Arif Mustafa Financial Reporting

We were able to collect data from the following sources 1. Ministry of Power and Water (Details about PEPCO) 2. The Oil Companies Advisory Committee (Oil Imports and Exports) 3. Oil and Gas Regulatory Authority (Oil Industry Sales Performance) 4. Economic Survey of Pakistan. (Economic health of Energy Sector) 5. Update on Oil Marketing Companies (JS Global Research). 6. Pak Arab Refinery (Ltd) PARCO. (Annual Reports) 7. Attock Refinery (Ltd) ARL. (Annual Reports) 8. National Refinery (Ltd) NRL (Annual Reports) 9. The Lahore Journal of Economics (Dynamics of Circular Debt in Pakistan and its Dimensions) The data collected had enough information about the Import and Export of Oil, Performance of OMCs, annual production of refineries, and the Economic condition of Pakistan. First we developed our understanding about the circular debt and its types. A thorough study of the collected data was carried out by all group members to further strengthen our understanding about Circular debt. Circular debt is a controversial topic and therefore prone to criticism, it was necessary for our team to support the topic with findings related to the OMC sector performance & Energy Sector Profile with Facts & Figures. Specific Financials of PSO were then used to show the Circular debts impact on the companys performance for the past 3-4 years. This Project required core knowledge about how to Read a Financial Report and interpret it. (which includes all financial ratios), Corporate Finance, Analysis of Financial Statements and Financial Management.

OUT COME

OF THE

PROJECT:I learned a lot from this project, as it was a team effort; the learning

was for the whole group. I learned about how the energy sector of Pakistan, how it works and the key players in the Energy Sector of Pakistan. My knowledge about the Circular debts dynamics in Pakistan further strengthened. My Learning related to the Project is as follows: Circular Debt is a debt in which all entities are the creditor and debtor at the same time. Circular Debts circle keeps on growing if any one entity in the circle defaults on payments.

Winter Internship (2011) Report by Arif Mustafa Financial Reporting

In Pakistan, the energy sector has faced this issue for several years. The resulting cash flow constraints have added to the operational inefficiencies of companies in the power sector. In some cases, power generation companies are operating below their capacity due to liquidity constraints.

The consequent increase in the power supply deficit has also contributed to supplyside constraints. Thus, it can be argued that buildup of circular debt has led to a reduction in the potential gross domestic product (GDP) of the country. If this is true, any policy incentive to growth could be less effective in terms of achieving the desired results The build-up of circular debt has led banks to accumulate alarmingly high exposures on the energy sectoroutstanding credit to Pepco, independent power producers (IPPs) and Shell (oil marketing company [OMC]) stood at just over Rs485 billion at end-December 2009. An overview of the Energy Sector which includes the following: 1. Primary Energy Suppliers: These include (a) oil/gas exploration companies (e.g., OGDCL and PPL), (b) oil refineries (e.g., ARL, Parco), and (c) distribution companies in gas (e.g., SNGPL, SSGC) and oil (e.g., PSO, Shell). All companies in this segment are involved in the supply of primary energy to power generation companies. 2. Power generation and distribution companies: These comprise the Independent Power Producers (IPPs) Addu Karachi

Electric Supply Company (KESC) (a vertically integrated company), (e.g., Hub Power Company and Kot Power Company), captive power producers, rental power producers,

WAPDA Hydel, and the Pakistan Electric Power Company (PEPCO). PEPCO is the core entity in the energy sector. It is an umbrella institution

Winter Internship (2011) Report by Arif Mustafa Financial Reporting

managing power generation companies (GENCOs), the National Transmission and Despatch Company (NTDC), and power distribution companies (DISCOs). Approximately 90 percent of the power generation in the country falls under

PEPCOs area of influence. So, PEPCOs Cash imbalance has trickled down in the energy sector and

also the pending government subsidies on the power tariff lead to the emergence of Inter-Corporate Circular Debt. This issue almost got out of hand in 2008 where the government decided to

issue two TFCs amounting to Rs 88bn and 81bn in the year 2009 in two phases. Circular Debt issue further made life difficult for PSO when the International

Oil prices fell from 140 $/barrel to 31$/barrel in the year 2009. This drastic fall in Global Oil prices and the global economic recession had

the worst effect on PSOs performance for the year 2009. PSOs got so severe hit that its reserves decreased from 29250Mn to 19156Mn Finance Cost Increased from 1368Mn to 6232Mn from year 2008-2009 and

from 6232Mn to 9882Mn from 2009 to 2010 due to rising Refinery Interest. An increase of 355% in the finance charges from year 2008-2009 clearly

shows the affects of the Sharp decline in Global Oil Prices. Increase of 58.56% in the finance charges shows the impact of Circular Debt. These finance costs increased mainly due to 2 reasons. One is the Falling international Oil Prices second is the Increase in Short term borrowings which the company had to rely on due to the liquidity crunch it is facing as a result of the

Winter Internship (2011) Report by Arif Mustafa Financial Reporting

circular debt. This year companys Performance has been on the better side as the Global Oil prices stabilize, Companys Financials also reflect a better picture as it received the two TFCs.

PROJECTIONS

FOR

FY 2011-2012

Compilation of the Project has been a great learning, as it provided the opportunity to look into the companys financials and analyze the true health of the Organization in terms of Liquidity Status. On the basis of my knowledge and the study of companies Financial Statements for the past 5 years, I Project the following: As the turnover tax has been reverted back from 1% to 0.5% this year, It has created a deferred tax (An asset) for the company which amounts to 29Bn Rs and it will be recognized in the coming FY 2011-2012. PSO is trying to further strengthen its Infrastructure which will reduce its CAPEX over the periods and lead to profit Maximization As the Global Oil prices stabilize, the company has great chance to recover from the liquidity crunch it faced in the last 2 years. The Ministry of Power and Water, and the Ministry of finance has been working on developing a bail-out Package for PEPCO, to move it out of the liquidity crunch hence giving PEPCO chance to operate at full capacity which will lead to additional demand of furnace Oil, of which PSO is a major Importer and holds a market share of more than 70%. PSO is an Equity Finance Company and hence these fruitful conditions will have positive impact on the companys share price.

Winter Internship (2011) Report by Arif Mustafa Financial Reporting

CONCLUSION:
The resolution of circular debt is necessary as this will ease supply constraints. The task is challenging since it requires the outstanding stock of circular debt to be cleared before plugging further build-up of circular debt receivables. One key lesson is that power subsidies can be sustained only if these are explicitly recognized in the fiscal budget; otherwise, the economy will continue to suffer from the indirect cost of these subsidies.

Winter Internship (2011) Report by Arif Mustafa Financial Reporting