Defusing the POL bomb  

Detonating POL bomb  

Huzaima Bukhari & Dr. Ikramul Haq

Rising need of petroleum and its heavy taxation leaves the common man stripped of his earnings, and renders the lives of the poor more miserable than before, but despite all these, brings in super duper profits to the petroleum companies and revenues in trillions for the government—Rana Bhagwandas Commission Report on Petroleum Prices submitted to Supreme Court of Pakistan in 2009

It is shameful that since independence we have failed to provide mass transit facility for at least 2 large cities—Karachi and Lahore—and bus service for every city and town despite burdening the citizens with all kinds of taxes. On the contrary, consumer loans were vastly disbursed under Musharraf-Shaukat era inducing massive purchase of personal vehicles resulting in enormous profits both for the petroleum companies and car manufacturers. Public transport has been the least priority of all regimes because of which the real sufferer is the common man who cannot afford personal transport. More and more cars on the roads cause pollution, traffic mayhem and are the main source of increase in our oil import bill—POL price hikes—necessary evil?, Business Recorder, July 8, 2010

These observations, made years ago, remain painfully relevant today. Once again, the government has unleashed a petrol bomb on citizens. The recent manipulation of petroleum levy—first raising it sharply and then partially reducing it—exposes the fragile political economy of Pakistan’s energy pricing. Temporary relief masks deeper structural distortions that continue to fuel inflation, expand circular debt and undermine economic growth.

The reduction in petrol prices by slashing petroleum levy by nearly Rs80 per litre may provide short-term relief, but it does not alter the fundamental reality: petroleum pricing in Pakistan has become a fiscal instrument rather than an energy policy tool. Governments raise levy when revenue targets fall short and reduce it when public pressure intensifies. This oscillation creates uncertainty for businesses, investors and households.

Only weeks earlier, petroleum levy climbed from around Rs105 per litre to nearly Rs160–161 per litre. This sharp increase pushed petrol prices to unprecedented levels and triggered inflationary pressures across the economy. Such hikes are justified as fiscal necessity, yet their economic consequences are immediate.

High fuel prices increase logistics costs, shrink industrial margins and weaken export competitiveness. Manufacturers either pass on costs to consumers or reduce production. Both outcomes slow economic activity. When fuel becomes expensive, the entire economy slows—effectively taxing the engine of growth to a stall.

Petroleum Levy: Easy Revenue, Heavy Cost

Petroleum taxation has historically been the easiest revenue tool for governments. Earlier studies showed that taxes and levies constituted between 44–55 percent of petroleum prices, making fuel pricing a convenient fiscal instrument. Governments continue to rely on petroleum levy instead of undertaking structural tax reforms.

This reliance on petroleum levy also distorts fiscal federalism. The government reduced General Sales Tax (GST) on petroleum products to zero, allowing it to collect petroleum levy without sharing proceeds with provinces under the National Finance Commission (NFC) Award.

Petroleum levy is non-divisible revenue, whereas GST must be shared with provinces. By shifting from GST to petroleum levy, the federal government centralised fiscal resources.

However, this arrangement is now under pressure. The International Monetary Fund (IMF) is reportedly pressing Pakistan to restore 18 percent GST on petroleum products. If implemented, either prices will increase or petroleum levy will have to be reduced further, shrinking federal fiscal space.

The Federal Board of Revenue (FBR) is already struggling to meet revenue targets. Reduction in petroleum levy reduces non-tax revenue, while GST restoration risks slowing economic activity. This creates fiscal uncertainty.

Unlimited Petroleum Levy: Constitutional Concerns

Another troubling dimension is the manner in which the government has acquired unlimited authority to impose petroleum levy.

Historically, petroleum levy was subject to statutory ceilings approved by Parliament. The Finance Act 2024 maintained this framework. However, the Finance Act 2025 omitted the Fifth Schedule and amended section 3 of the Petroleum Products (Petroleum Levy) Ordinance, 1961, granting the federal government unrestricted authority to determine petroleum levy through executive notification.

This effectively transferred unlimited fiscal authority to the executive.

The amendment was made through a Money Bill, bypassing Senate oversight. Petroleum levy is not a tax under Article 77 of the Constitution, yet it functions as a major revenue instrument. Delegating unlimited authority to the executive raises serious constitutional concerns. Petroleum levy is also not part of the divisible pool under NFC. Increasing reliance on petroleum levy therefore reduces provincial revenue share and centralises fiscal power.

The recent fluctuations in petroleum levy illustrate how executive discretion now determines petroleum pricing without statutory limits.

Oil Prices, IPPs and Capacity Payments

Pakistan’s electricity generation remains heavily dependent on imported fossil fuels. When oil prices increase, electricity generation costs rise automatically.

Under long-term contracts, the government must pay capacity payments to Independent Power Producers (IPPs), many of which are indexed to the US dollar. These payments must be made regardless of electricity consumption.

Government disclosures indicate that payments to IPPs increased from Rs. 487 billion in fiscal year (FY) 2022-23 to over Rs923 billion in FY 2023-24. Overall capacity payments now range between Rs1.8 to Rs2 trillion annually.

When oil prices rise, fuel cost adjustments and exchange rate movements further increase these payments. Thus, petroleum price hikes indirectly increase fiscal liabilities.

Circular Debt Explosion

Pakistan’s circular debt remains one of the biggest macroeconomic risks. Power sector circular debt, which declined to Rs. 1.614 trillion by June 2025, has again risen to around Rs. 1.9 trillion. Gas sector circular debt is estimated at around Rs. 3.2 trillion. Combined, Pakistan’s energy sector circular debt now exceeds Rs. 5 trillion.

The mechanism is straightforward. Pakistan State Oil supplies fuel to power plants. Power plants generate electricity supplied to distribution companies. Due to inefficiencies, theft and delayed tariff adjustments, distribution companies fail to recover full costs. Payments are delayed across the chain, creating circular debt.

When oil prices rise, fuel costs increase, capacity payments expand and circular debt grows further.

Inflationary Impact

Petroleum price hikes trigger inflation across the economy. Transport costs increase first, followed by food prices, electricity tariffs and industrial costs. Export competitiveness declines, growth slows and unemployment increases.

Pakistan’s inflation remains highly sensitive to fuel prices. Even temporary reductions rarely reverse inflation fully, as electricity tariffs and gas prices remain elevated. Thus, petroleum pricing remains one of the most important drivers of inflation.

Missing Policy: Public Transport and Energy Transition

Despite decades of heavy taxation on petroleum products, Pakistan has failed to develop mass transit infrastructure. Instead, policies encouraged private vehicle ownership, increasing oil imports and worsening energy dependence.

Pakistan’s oil import bill now approaches $20 billion annually, creating pressure on foreign exchange reserves.

Investment in public transport, railways and renewable energy could reduce fuel dependence and inflationary pressure.

Yet these structural reforms remain absent.

Political Economy of the Petrol Bomb

The repeated use of petroleum levy as a fiscal tool reflects deeper structural weaknesses. Governments rely on petroleum pricing because it is easy to impose and difficult to resist. However, this approach slows economic growth, increases inflation and expands circular debt.

Pakistan therefore oscillates between petrol price hikes and temporary relief—without addressing underlying structural problems.

Conclusion

The latest petrol bomb—followed by partial relief—illustrates the fragile political economy of Pakistan’s energy sector. Rising oil prices increase capacity payments, expand circular debt and fuel inflation. At the same time, constitutional changes granting unlimited authority to impose petroleum levy have weakened parliamentary oversight and centralised fiscal power.

Pakistan’s energy pricing decisions now influence growth, inflation, fiscal deficit and federalism simultaneously. Without structural reforms, petrol bombs will continue to return—each time with greater economic consequences. The political economy of petroleum pricing has thus become central to Pakistan’s economic future.

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Huzaima Bukhari, lawyer and author, is an Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Senior Visiting Fellow of Pakistan Institute of Development Economics (PIDE)

Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.