NEW ERA IN OIL SECTOR
E.C.Thomas
A new era has begun in India’s oil
sector; with the Government dismantling the three decade-old administered
pricing mechanism (APM). The oil sector deregulation has come with effect
from April 1, 2002, after six years of hectic debate on the issue.
The dismantling
of the administered pricing mechanism means that oil companies are free
to take independent decisions based on import parity and market forces
in pricing of petroleum products rather than being governed by the dictates
of the Government. The public sector oil companies have also to face a
competitive marketing environment now.
The APM was created
after the Government nationalized the international oil majors – Caltex,
Esso and Burmah Shell in the early 1970s. With the APM, the Government
had also established a complex system of Oil Pool accounts, which was administered
by the Oil Coordination Committee (OCC).
Dismantling of
the APM has also led to the winding up of the Oil Pool account. The Oil
Pool account is estimated to have a deficit of Rs. 13,000 crore, which
is outstanding dues to the oil companies as on 31.3.2002. The account is
being liquidated by issuance of Government bonds to the concerned oil companies.
While immediate issuance of Rs. 9,000 crore has been earmarked in the Supplementary
Demands for Grants for 2001-02, the balance would be given out after settlement
of the pending claims and completion of CAG audit.
The OCC has been
reduced to Petroleum Planning and Analysis Cell under the Petroleum Ministry
to oversee the functioning of the downstream oil companies. The Cell will
also deal with issues arising out of deregulation of prices till the proposed
Petroleum Regulatory Board is constituted.
Although oil
companies are now free to set their prices for petroleum products, migration
from a regime of price controls to the free market will take some months.
Therefore, the customers need not worry. The current prices will be held
at least for the next three months of the transition period. Both the Petroleum
Minister, Shri Ram Naik and Indian Oil Corporation Chairman, Shri M. S.
Ramachandran have already assured the consumers that prices will remain
unchanged for the next few months. This is to ensure a smooth switch-over
from administered pricing regime to a deregulated market.
In Administered
Pricing, under the cost plus formula, prices of all petroleum products
are fixed on the basis cost of procuring and refining crude oil. Cross
subsidization among petroleum products was in existence under the administered
pricing mechanism. The prices of petrol and diesel subsidized the prices
of liquefied petroleum gas (LPG) and kerosene. The APM ensured a 12 per
cent post-tax return to the oil companies. This is lower than those prices
determined by the free market.
Beyond the three-month
period, market-determined pricing principle sinks in the system. But the
Government will continue to provide a flat rate subsidy of Rs.3 a litre
for kerosene supplied through the Public Distribution System and Rs.90
for cooking gas cylinder. Besides, freight subsidies for supply of PDS
kerosene and LPG in the far-flung areas of the country would also be provided
by the Government. This subsidy would be phased out within a period of
three to five years.
However, according
to the Union Budget for 2002-03, the dismantling of administered pricing
will fetch the Government a net bounty of Rs. 720 crore. The Finance Ministry
will mop up around Rs. 7,200 crore from the sector through excise and customs
duty hikes and special cesses and surcharges but will spend only Rs. 6,495
crore on subsidies during the year.
Subsidy has been
restricted to cooking gas (LPG) and kerosene. Even the freight subsidy
for far-flung areas is confined to LPG and kerosene. The Government will
earn Rs. 3,100 crore from the specific surcharge of Rs. 6 per litre of
petrol and excise duty of 32 per cent on the fuel. An amount of Rs. 2,400
crore will be extracted from ONGC as doubled cess on domestic crude. The
enhanced customs and excise duties on kerosene and LPG will further yield
Rs. 1,800 crore.
As the oil industry
moves into decontrolled era the oil companies will be free to set their
prices linked to fluctuations in global crude prices. Before setting prices
the oil companies will calculate the net overall impact of the free market
on their margins. This will determine whether prices will move up, down
or remain static. Due to freight costs, the prices in the hinterlands may
be higher than in coastal areas, though the Government is trying to narrow
any difference by using the market leader, Indian Oil Corporation, to determine
the market prices. However, the rules of the game are expected to change
dramatically when private sector oil companies enter the retail marketing.
The pace of competition will pick up with the privatization of HPCL and
BPCL. Then retail prices could differ by 1-2 per cent from company to company.
Once the initial
dust of deregulation settles down and the oil companies figure out the
market mechanism, consumers can expect fluctuations in the prices of petroleum
products. Once private firms step in and set up their own marketing infrastructure
and retail outlets, competition could even spur undercutting, which could
only benefit the consumer. Domestic prices of petroleum products would
be a reflection of increase or decrease in global prices plus freight and
local taxes. Retail prices of petrol and diesel will vary from one place
to another. Essentially, this would mean that coastal areas would have
lower prices compared to inland locations, which would be saddled with
additional freight.
The public sector
oil companies have a decisive edge in marketing products due to their superior
infrastructure network. New entrants into the petroleum product-marketing
arena will be only those who have invested or proposed to invest Rs. 2,000
crore in oil infrastructure. Authorization to grant marketing rights would
be issued by the Petroleum Ministry till a Regulator Board for the downstream
petroleum sector is set up. Under the criteria, the companies which already
stand qualified for marketing of petroleum products from April 1, 2002
include the Oil and Natural Gas Corporation (ONGC), Oil India Ltd. (OIL),
Gas authority of India (GAIL) Reliance Industries (RIL), Essar Oil, Carin
Energy of UK and Mangalore Refineries and Petrochemicals (MRPL). The proposed
regulatory board would lay obligations on the new entrant companies to
set up marketing infrastructure including retail outlets in remote and
low services areas. The Government/regulatory board would have the power
to cancel the marketing authorization if the eligible company fails to
set up retail outlets in the remote and lower service areas as directed.
Retail presence,
logistics arrangement and risk management would be the three critical factors
for oil companies to succeed in the new competitive free market. Extensive
retail presence would be the most critical success factor for companies.
Replicating the retail set up of the IOC, HPCL and BPCL would be a gigantic
effort for any new player. These three companies together account for about
19,000 retail outlets including franchises. The established marketing companies
have pipelines and storage facilities but they have to make huge investments
to expand these facilities for their own needs. New entrants will have
to build new facilities as soon as possible.
Moreover, so
far risks were almost nil in marketing as companies had fixed margins and
prices fixed under APM. Now the companies have to deal with risks including
price risk for crude oil, refining margins and foreign exchange risks.
Assured margins are now a thing of the past and companies will need to
adopt global risk management practices to protect their margins.
Oil companies
at present source import crude oil through tenders, which is a time consuming
process. This does not reflect, the prevailing market prices, which fluctuate
on a daily basis. All international majors like Shell, Exxon, Mobil and
Chevron have energy trading departments which monitor crude prices on daily
basis to protect the company from price fluctuations and reduce the impact
on its net profits. In this situation also, the public sector oil companies
are now better placed in the deregulated regime. It would be two to three
years before new private entrants challenge their market leadership.
The retail marketing
margins of oil companies are expected to be up by one per cent in the new
era of free market pricing, according oil industry experts. Margin expansion
would be highest in retail automotive fuels of diesel and petrol, the areas
of real competition. The automotive fuels account for nearly 50 percent
of the total volume sales. The domestic diesel sales stood at 40 million
tonnes while that of petrol is at 8 million tonnes during 2001-02. Kerosene
sales accounted for 10 million tonnes during the year.
India’s total
consumption of petroleum products during 2001-02 is estimated at 100 million
tonnes. The net imports of petrol and diesel stood at 3 million tonnes.
The author is
a freelance writer.
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