Indian Oil Corporation Ltd

(Forming part of the Directors’ Report for the year ended 31st March 2011)

The return of Growth

The year was marked by a significant improvement in the overall global businessenvironment, as growth returned to the advanced economies and accelerated in the emergingeconomies. India and other emerging economies registered high growth rates and have beenthe front runners in the recovery, particularly led by Asian emerging economies.

Key Downside Risks

The weak sovereign balance sheets in the Euro area and a fragile financial system inthe advanced economies pose a risk to growth, with widespread repercussions across theworld.

The rising crude oil prices and other commodity prices pose a major downside risk andrising inflation is one of the major threats, especially in India and other emergingeconomies. In fact, in the last few months, with a prominence of these risks, globaleconomic activity has exhibited signs of a slowdown.

Growth Inflation Trade off

In India, the policy dilemmas increased as repeated attempts to rein in inflationfailed. The successive rounds of monetary tightening will trade off growth for inflationcontrol which assumed the priority of the monetary authorities. Interest rates continue toharden in the country as the monetary policy tightens. In the last quarter of 2010-11, GDPgrowth decelerated to 7.8% from 8.3% in the third quarter and from 9.4% in thecorresponding quarter of 2009-10. While most agencies are in agreement that a slowdown isimminent, growth is still expected to be above 8% per annum in the next 2-3 years.

Rebound in Demand

Driven by economic recovery, global energy consumption recorded the strongest growthsince 1973. In 2010, world oil consumption rebounded at around 88 million barrels per dayexceeding its pre-crisis peak, growing by 3.3% on a year-on-year basis. While the growthwas broad-based across OECD & Non-OECD country groups, it was the emerging economies,which led the demand. Oil consumption in the BRIC country group grew by 9.3% in 2010, withChina leading the group at 12.5%. The supply side registered higher production, but themarket remained tight as the rise in production did not fully match the rise inconsumption, resulting in intermittent draw down of inventories and pressure on theprices. Towards the end of 2010-11, the upward movement of crude oil prices steepened asthe political turmoil in Middle East & North Africa (MENA) region, accompanied bysupply outages from Libya, hit the oil market.

Return of High crude oil prices

In less than two years, oil prices are back to the US$100/bbl range and are againreshaping energy policy and business. With high oil prices, the focus is once againturning to Bio-fuels, Shale gas, Oil sands and other unconventional Oil sources andRenewables.

Buoyant Indian Transportation Fuel Market

Propelled by the continuing growth of the economy, petroleum products consumption grewby around 2.9 per cent during the year. It was the transportation fuels segment comprisingMS, HSD & ATF that led the growth in consumption. The accelerated growth in demand forpetrol, despite deregulation of prices during the year, highlights the capacity of themarket to absorb higher prices. Industrial fuels witnessed a decline in demand mainly onaccount of substitution by natural gas. However, Naphtha recorded a robust growth due tonaphtha feedstock based Petrochemicals units in the country. LPG recorded significantgrowth, helped by a policy thrust aimed at LPG penetration in rural areas through theRajiv Gandhi Gramin LPG Vitaran Yojana (RGGLVY).

Source: PPAC

Domestic Pricing Policies: Gradual Change

Price control is still applicable on three major products viz. HSD, SKO (PDS) &LPG(Dom). In this context, with the return of high crude oil prices, under-recoveries forPSU Oil Marketing Companies (OMCs) have continued to soar. However, there is a gradualshift in the Government policy from the present system of indirect subsidies to directsubsidies. The Government is considering direct subsidization of LPG & SKO throughcash transfers. Should the policy change materialise, it may bring relief to the PSU OMCsfrom the financial burden of under-recoveries in the near future.

Strengthening of India as a Refined Products Exporter

With international oil demand rising during the year, the export market for Indian POLexports expanded further. POL exports from the country grew rapidly and have emerged asthe highest foreign exchange earner for the country.

The Refining sector in the country has been growing at a fast pace and Indianrefineries clocked a capacity utilization of over 100 per cent to meet the rising domesticand export demand. While, quite a few capacity expansions in the refinery sector came onstream during the year, other major expansions are underway. During the year, a landmarkachievement was the successful countrywide launch of upgraded BS-IV (13 cities) and BS-IIIPetrol and Diesel (in rest of the country) in line with the Auto Fuel Policy road map.

Rising Domestic Oil Production

The country moved away from the scenario of stagnating domestic oil production.

During the year, with new crude oil discoveries, production went up by 11.9 percent toreach 37.7MMT during the year.

Growing Natural Gas Sector

Global natural gas consumption grew at a record 7.4% in 2010 and with shale gas comingon stream, the United States remained the largest producer of gas. This has considerablyenhanced prospects for LNG imports for countries like India. Further, looking at theabundance of gas in the US, the conversion of LNG import facilities there into exportpoints is also being seen as a possibility in the future, which would add to the buoyancyof the international gas market.

During the year, domestic production of Natural Gas in India rose by 10 % to 52.2 BCM.From the point of view of the long term supply scenario, two positive developments on theenergy diplomacy front were India’s signing of Intergovernmental Agreement and GasPipeline Framework Agreement for the Turkmenistan- Afghanistan-Pakistan-India (TAPI)pipeline and a MoU between US & India for technical co-operation in Shale gas.

OPPORTUNITIES AND CHALLENGES / STRENGTHS AND WEAKNESS

The Indian energy market is amongst the largest in the world. Further, the sector isexpected to continue to grow at high rates, much above the developed world and globalaverage in the long term. This growth will be largely propelled by the fast growth of theIndian economy, rapid rate of urbanization and the urgent need to supply energy tomillions of Indians who are trapped in energy poverty. As a key supplier in such a market,the Corporation foresees ample growth opportunities for itself, which are further enhancedby the increasing thrust of the policy initiatives for energy sector development. TheCorporation’s vision is to be the ‘Energy of India’. Business strategiesare focused on strengthening the core business, as petroleum products are and willconstitute a major energy source. Along with this, the Corporation’s focus area willbe to expand its presence in other energy sectors to cater to the ever growing energyneeds of the economy.

Growing Domestic Market

India’s high economic growth has been driving up the demand for petroleumproducts. In times to come, competition levels are expected to rise in the domestic spaceand the Corporation would stand focused on strengthening its competitive edge by providinghigh quality services and products to its customers.

Rural Energy Deficit & Potential

Within the domestic market, the Corporation is also focusing on the rural market. Thecorporation’s rural marketing model is based on low cost, no-frills retail outlets,named Kisan Seva Kendra (KSK) for providing fuel and non fuel rural-centric services. Therenewed thrust of the Government towards providing basic energy needs to Below PovertyLine (BPL) families through schemes such as Rajiv Gandhi Gramin LPG Vitaran Yojana, inwhich the Corporation is partnering, gives further impetus to the efforts in reaching tothe vast rural market.

International Downstream Marketing Opportunities

In the international petroleum product market, the Asia-Pacific Region has emerged asthe leading growth centre for petroleum demand and is expected to turn into the largestimporter of petroleum products in the near future. In addition, other emerging markets inthe world are also experiencing rapid growth in petroleum product demand. The Corporationaims to explore opportunities presented by these fast growing demand centres throughappropriate business models.

Downward Integration in Petrochemicals

The Corporation has made significant strides in the downward integration intopetrochemicals business in the recent past. The strengthening of India’smanufacturing base has resulted in a robust growth in petrochemicals demand. TheCorporation, armed with its investments in petrochemicals, aims to garner theopportunities presented by the growing petrochemicals demand in the country besides theniche and high specialty chemical product markets. In addition to this, the Corporationalso aims to enhance its petrochemicals exports.

Upward Integration into Exploration & Production

With the objective of enhancing the energy security of the country and the upwardintegration of its business, the Corporation has been in pursuit of tapping E&Popportunities through a consortium approach. Having built up a portfolio of blocks, bothwithin and outside the country, the Corporation awaits a significant breakthrough.

Growing Gas Supply Opportunities

The improved gas supply in the country and the limited gas infrastructure presents aconsiderable investment opportunity in gas transportation infrastructure. The constructionof pipeline networks, both cross country and for city gas distribution, will provide anopportunity to the Corporation to serve value added propositions. The prospects of LNGimports to the country have turned positive in the last couple of years and theCorporation plans to expand its LNG business.

Alternative Energy Space

The Corporation’s commitment to sustainable development has led to initiatives inrenewable energy like Bio-fuels, Wind, Solar & Nuclear Power. Moreover, with highcrude oil prices, the attractiveness of investment in these energy sources has increasedconsiderably. A conducive policy environment under the Government’s National Actionon Climate Change, is seen as a major catalyst in making renewable energy investmentsattractive. In the domain of nuclear energy, the Japanese nuclear disaster came as a majorsetback. However, the nuclear renaissance in the country will continue albeit with anextraordinary thrust on safety and regulation and the Corporation is keen on garneringopportunities in this domain.

Research & Development

The Corporation has always valued the importance of research & development in thelong term growth of its business and this is being widened to design strategies fordevelopment in newer areas. In the area of Product Development, the focus is on thedevelopment of environment friendly, emission compliant, energy efficient and long drainoils. During the year, the Corporation also created state-of-the-art R&Dinfrastructure for supporting petrochemical plant operations. In the alternative energyspace, research work has been initiated in the area of second generation biofuels,co-processing of vegetable oils with refinery streams, algae oil and bio-hydrogen.

Sustainable Development

The Corporation appreciates the merits and the necessity of sustainable development andis committed to sustainable business practices. In the pursuit of 'Carbon Neutrality', sixrefineries of the Corporation have recently received the 'Greenhouse Gases VerificationStatement'.

Further, in the context of Corporate Social Responsibility (CSR), which is an importantdimension of sustainable development, the Corporation views it as an opportunity to createfoundations for a sustainable business by integrating society & environment into ourbusiness practices. The Corporation intends to make its KSKs and its initiatives underRGGLVY as the nodal points of delivery for its CSR activities in rural areas in the areaof healthcare for the really needy and poor sections of the society.

Widening Scope of MoU

Through its Memorandum of Understanding (MoU) with the Public Sector Undertakings, theGovernment of India has been bringing enhanced focus on issues critical for the long termwell being of enterprises such as CSR activities, Research & Development, SustainableDevelopment, Human Resource Development and Corporate Governance. The corporation hasalready incorporated targets pertaining to these areas in its MoU with the Government.Thrust on these areas will go a long way in establishing a long term competitive edge tothe Corporation.

Human Capital Challenge

Currently, to get quality HR Talent is a challenge. For the Corporation too nurturingand retaining the desired skilled workforce has been an area of focused attention. That‘an organization is as good as its people’ is an old adage. It is a tribute tothe spirit of IndianOil that it was adjudged as one of the ‘Best Companies to Workfor’ in India by the Great Places to Work Institute.

Challenge of Policy Regime and High Prices

The deregulation of petrol prices in June 2010 came as a positive policy development.However, major products such as Diesel, LPG(Dom) & SKO(PDS) are still under pricecontrol. Although, there has been a shift from provision of oil bonds to cash compensationagainst under recoveries, the delay in compensation, coupled with rising international oilprices has led to very high levels of borrowings, causing stress and strain to thefinancial health of the Corporation. Albeit no one can predict oil prices and high crudeoil prices are here to stay and this would be a continuing challenge for the Corporation.In the face of these external challenges, our constant endeavour is to further optimizeour crude basket and turn higher value products besides improving productivity andreducing costs.

Supply Shocks

The geo-political risks have been inherent to the international oil market and thisyear saw this risk turn into a reality and is expected to remain high in the comingmonths.

Escalated Debt Levels

The Corporation’s debt is at a significantly high level and with interest rates inthe country hardening due to anti-inflationary policies, the debt servicing burden on theCorporation has been increasing and is an area of concern. As a risk mitigating strategy,the corporation has been increasing the share of foreign currency loans in its mix ofborrowings.

High Domestic Inflation

In the context of high domestic inflation, the passing of high international crudeprices to consumers in respect of sensitive products may become increasingly difficult forthe Government. Should the inflation level in the economy remain high, it would act as afurther deterrent in raising petroleum product prices. The Corporation would, however,continue to seek 100% reimbursement from the Government on account of under recoveries onsensitive products to insulate its position. The confluence of high domestic inflation andhigh international crude oil prices poses a considerable business challenge.

Forex Fluctuations

The Corporation engages in large scale foreign exchange transactions. In view of theinstability of global capital flows, especially in the present economic environment, theCorporation has been using various cushioning strategies to limit the adversities of forexfluctuations resulting from volatile capital flows.

Safety & Security

For the corporation’s refinery, marketing and pipeline infrastructure, safety andsecurity is a priority concern at all times and at all locations.

The Corporation operates in a very dynamic and a very critical business sector, whereboth opportunities and risks abound. The Corporation reaffirms its commitment to make allendeavors for augmenting shareholder value, while exercising adequate caution to minimizerisks.

FINANCIAL REVIEW

Turnover

The turnover of your Corporation (inclusive of excise duty) for the year 2010-11 wasRs. 3,28,744 crore as compared to Rs. 2,71,095 crore in the previous year, registering anincrease of 21.3%. The total sales of products (including gas and petrochemicals) for2010-11 was 72.92 MMT as against 69.92 MMT during 2009-10, registering an increase of4.3%.

Profit Before Tax

The Corporation has earned a Profit Before Tax of Rs. 9,096 crore in 2010-11 ascompared to Rs. 14,106 crore in 2009-10, registering a decrease of 35.5%.

Provision for Taxation

An amount of Rs. 1,651 crore has been provided towards income tax for 2010-11considering the applicable income tax rates as against Rs. 3,885 crore provided during2009-10.

Profit After Tax

The Corporation has earned a Profit After Tax of Rs. 7,445 crore during the currentfinancial year as compared to Rs. 10,221 crore in 2009-10,registering a decrease of 27.2%.

Depreciation & Amortisation

Depreciation for the year 2010-11 was Rs. 4,567 crore as against Rs. 3,240 crore forthe year 2009-10.

Interest (Net)

Net Interest Expenditure of the Corporation for the current year was Rs. 1,121 crore asagainst net interest income of Rs. 446 crore during 2009-10.

Borrowings The borrowings of your Corporation were Rs. 52,734 crore as on March31st, 2011 as compared to Rs. 44,566 crore as on March 31st, 2010. The Total Debt toEquity ratio as on 31st March, 2011 works out to 0.95:1 as against 0.88:1 as on 31stMarch, 2010 and the Long Term Debt to Equity ratio stands at 0.34:1 as on 31st March, 2011as against 0.36:1 as on 31st March, 2010.

Capital Assets

Gross Fixed Assets (including Capital Works in Progress) increased from Rs. 93,358crore as on 31.03.2010 to Rs. 1,05,785 crore as on 31.03.2011.

Investments

Investments as on 31st March, 2011 were Rs. 19,545 crore as compared to Rs. 22,370crore as on 31st March, 2010. The decrease in investments during the year is mainly due tosale of Government of India Special Oil Bonds. The aggregate market value of quotedinvestments as on 31st March, 2011, i.e., investments made in ONGC Ltd., GAIL (India)Ltd., Oil India Ltd., Chennai Petroleum Corporation Ltd., Petronet LNG Ltd. and Lanka IOCPlc., is Rs. 25,141 crore (as against the acquisition price of Rs. 3,828 crore).

Net Current Assets

Net Current Assets stood at Rs. 24,008 crore as on March 31st, 2011 as against Rs.14,637 crore as on March 31st, 2010.

Earnings Per Share

Earnings Per Share works out to Rs. 30.67 for the current year as compared to Rs. 42.10in the previous year.

Earnings in Foreign Currency

During the year, the Corporation earned Rs. 16,968 crore in foreign currency as againstRs. 13,743 crore in 2009-10, which is mainly on account of export of petroleum products.

(Rs. in crore)

Notes:

A. Segment Revenue comprises Turnover (Net of Excise Duties), Subsidy & Grantsreceived from Government of India and Other Operating Income.

B. Other Business segment of the Corporation comprises; Sale of Imported Crude Oil,Sale of Gas, Oil & Gas Exploration Activities, Explosives & Cryogenic Business andWind Mill Power Generation.

INTERNAL CONTROL SYSTEMS

The Corporation has adequate internal control systems commensurate with the size andnature of its business. In addition, there are detailed manuals on various aspects of thebusiness activities, accounting policies and guidelines. The Board of Directors regularlymonitors the performance of your Corporation. Further, the Corporation has a full-fledgedindependent Internal Audit Department headed by an Executive Director (below Board level),who reports to the Chairman. The Internal Audit carries out extensive audits, round theyear, covering each and every aspect of business activity so as to ensure accuracy,reliability and consistency of records, systems and procedures. An Audit Committeecomprising of independent Directors and constituted by the Board of Directors reviews therecommendations and observations of the Internal Audit Department regularly.

HUMAN RESOURCES / INDUSTRIAL RELATIONS

The industrial relations climate in the Corporation remained harmonious, peaceful andcordial during the year. Employees’ participation has been ensured throughinformation sharing with employees regularly seeking their support, suggestions andco-operation. Employees’ participation Schemes like shop floor councils and plantlevel councils are functioning in the Units. IndianOil continues to align its HRstrategies with organisational strategies. The pay revision for workmen effective01.01.2007 has been implemented during the year. The employee strength of IndianOil as on31st March, 2011 was 34,105 including 14,497 officers.

Information regarding Corporate Social Responsibility, Environmental Protection andConservation, Technological Conservation, Renewable Energy Developments, and ForeignExchange Conservation has been included in the Directors' Report and Annexure thereto.

CAUTIONARY STATEMENT

Statements in the Management’s Discussion & Analysis, describing theCompany’s focal objectives, expectations or anticipations may be forward lookingwithin the meaning of applicable securities, laws and regulations. Actual results maydiffer materially from the expectations. Important factors that could influence theCompany’s operations, include global and domestic demand and supply conditionsaffecting selling prices of products, input availability and prices, changes in Governmentregulations/ tax laws, economic developments within the country and factors such aslitigation and industrial relations.