Making money in the oil value chain

IN FOCUS / PETROLEUM REFINING

The entry on new players in petroleum marketing has raised a lot of excitement, but it is the refining segment of the oil business that is currently making money.

Marketing operations have been incurring losses under the existing duty and pricing structure, with companies being denied permission to raise prices.

Reduction in subsidy on LPG and SKO under the Union budget had negative implications for marketing operations of oil companies, the ICRA information, grading and research service (Ingres) said in a report released recently.

The first quarter of 2004-05 witnessed strong growth in refining margins coupled with provisioning for discount receivable from ONGC,Gail and OIL on account of their sharing of subsidy under-recovery on LPG for domestic users and SKO distributed through the PDS.

Thanks to government policy, some of the under-recovery burden was passed on to ONGC, Gail and OIL to reduce losses suffered by refining and marketing PSU companies.

Government refusal to allow increase in retail prices of auto fuel hit oil marketing companies, said the report.

At the same time, recent changes in the duty structure had lowered the duty protection enjoyed by refineries and could erode refining margins but still ensured adequate profits, ICRA said.

For integrated players, decline in refining margins were compensated by stable marketing margins and expected lowering of the under-recoveries in LPG and SKO.

The report pointed out that overall, the oil refining and marketing sector could bank on growth on the back of positive trends in the country's economy.

Refining companies were faced with surplus capacity in most products but the current duty structure continued to protect their margins.

The report warned though that oil marketing would suffer if the government continued to prevent companies from passing on increases in the price of crude oil to buyers despite the existence of an agreed formula for price increases.

Marketing would continue to attract investments in view of growth prospects, said the report. Marketing companies could seek to tide over this earnings crunch through initiatives like launch of premium products, development of alternate earning streams from retail outlets through sale of non-fuel items and providing value-added services.

The sector had seen several major policy changes in the last few months, ICRA stated.

The government, which owns dominant industry players like Indian Oil Corp Ltd (IOC), Bharat Petroleum Co Ltd (BPCL) and Hindustan Petroleum Co Ltd (HPCL), revised prices and changed the duty structure recently.

In view of the rising international oil prices and the stagnant retail prices of LPG, SKO, MS and HSD, the government on July 15, 2004, hiked the prices of petrol and diesel by Rs 2 and Re 1 per litre respectively. LPG prices were increased by Rs 20 per cylinder but kerosene prices were kept unchanged.

To minimise the impact of high prices of petroleum products on consumers, the duty structure was also changed. The excise duty on HSD was reduced by 3 per cent to 11 per cent , on petrol by 4 per cent to 26 per cent and for LPG, it was halved to 8 per cent.

The Union budget for 2004-05 reduced the subsidy on LPG/SKO by 46 per cent from Rs 6573 crore to Rs 3559 crore.

The report commented that the decision to reduce subsidy to downstream refining and marketing companies like IOCL, HPCL and BPCL along with other companies like ONGC Ltd and Gail Ltd implied that the government expected these entities to bear a large portion of the under-recovery in LPG and SKO.

In July 2004, the government allowed the oil marketing PSUs (public sector undertakings) to revise the auto fuel prices in a limited range. Under the formula, every fortnight, the mean of three months' average landed price of petrol and diesel and last one year's rolling average price would be calculated. Ten per cent of this mean price would be the ceiling and floor within which oil firms could revise rates.

However, in reality, oil companies have been prevented from raising prices despite extreme volatility and a steady rise in price of crude oil and its post-refining products.

The other side of this coin was sharp improvement in profitability of IOC and HPCL.

In BPCL's case (on a standalone basis), profitability was hit by marketing division losses as its market sales were over 2.5 times its refinery production.

Improvement in refining margin coupled with subsidy sharing by ONGC, Gail and OIL could not compensate for the losses incurred in auto fuel and LPG/SKO retailing by BPCL, which witnessed 54 per cent decline in net profit.

On a consolidated basis, though, BPCL's decline in profit was lower at 26.7 per cent owing to improvement profits of its refining subsidiaries like Kochi Refineries Ltd (KRL) and Numaligarh Refineries Ltd (NRL).

Private sector refining giant Reliance processed 7.9 million tonnes of crude in the first quarter of this fiscal.

It achieved refinery capacity utilisation of 96 per cent and exported 2.5 million tonnes of refined fuels.

Refining revenues of Reliance rose 19 per cent to cross Rs 12,000 crore and profit before interest and tax was 39 per cent more at Rs 1110 crore. Its return on capital employed was 18.7 per cent.

Consumption of petroleum products witnessed 9.5 per cent growth in the first quarter (Q1) of 2004-05, against a 2.7 per cent decline during Q1 of 2003-04.

This consumption growth has led by 12 per cent rise in HSD (high speed diesel) demand as against a decline of 5.8 per cent during Q1 of 2003-04.

Other products witnessing increased demand growth included LPG or liquefied petroleum gas (18.5 per cent), MS or motor spirit (7.6 per cent) and naphtha (3 per cent). Kerosene sales however declined 2 per cent.