Competition to get tougher

IN FOCUS/ OIL REFINING

Indian energy refineries are set for tough times in the auto fuels segment as new entrants such as Reliance Energy will lead to tough competition in the near future.

Market observers say that emerging competition in auto fuels can erode high marketing margins. This problem will likely be exacerbated by sizeable retail outlet expansion by incumbents. New entrants will not be under compulsion to subsidise loss-making products resulting from high auto fuel margins.

Analysts also believe marketing margins could get crushed in the industrial fuels segment which was as much as 20 per cent of the sales volumes of marketing companies. The 40 per cent price differential between natural gas and industrial fuel prices was another cause for worry.

Furthermore, refiners may be forced to change refinery configuration which was an expensive process entailing high capital expenditure if natural gas were to result in reduced consumption of bottom-of-the-barrel products. Industrial fuels were at present a profitable product basket.

According to a report by Kotak Securities, high import tariff protection in the oil sector was unlikely to last.

Although the differential between import tariffs on product and crude appeared low at 7 per cent currently, this translated into effective tariff protection of over 100 per cent for Indian refiners.

However, some of the analysts believed the growth story was yet to play out. In India, refining had been fully deregulated "in spirit" and margins reflected international trends.

Marketing margins were clearly under pressure as consumer prices of retail fuels were insulated against international volatility in prices. Flat prices also aggravated competition affects marketing margins. In contrast, refinery margins were clearly insulated from such aberrations.

Further, the huge domestic market for petroleum products offered a "local advantage" of $1.5-2.0 /bbl to domestic refiners on account of import tariff protection. Duty levels were proposed to be restructured in a phased manner but there had been little progress on the front since peak duty levels were already well within the targeted level of 20 per cent.

Ex-Singapore gross refining margins (GRMs) averaged more than $2.5 /bbl in 2003, up 4-fold from lows of less than $0.5 /bbl in 1998/1999. The upswing reflects a correction in the demand-supply imbalance in the Asia-Pacific region as an aftermath of the south-east Asian crisis of late 1990's.

Through 1999-2003, demand growth had outpaced capacity addition, absorbing the region's surplus capacity of 1 mb/d in 1999.

Going forward through calendar year 2008 (CY08), incremental demand in the Asia-Pacific region was expected to outstrip capacity addition by a margin of more than 2:1, thereby fuelling further upsides. As a result, globally, refining margins were on an upswing.