Chennai Petroleum Corporation Ltd

BSE: 500110 | NSE: CHENNPETRO | ISIN: INE178A01016 
Market Cap: [Rs.Cr.] 1,053.46 | Face Value: [Rs.] 10
Industry: Refineries

Management Discussions

(Forming part of the Directors’ Report for the year ended 31.03.2014)

Economic Overview

The global economy has shown signs of recovery in spite of many challenges andregistered a growth rate of about 3.0 % during 2013-14 as compared to 3.2% growth rate inthe previous year. However, the economic growth during 2013-14 across the countries wasuneven, with developing countries like China and India being major contributors while theEuro region experienced almost nil growth during the year.

It is also expected that the global economic growth will continue to gain momentum andis expected to grow further during 2014-15, with advanced economies like United States andEuropean Countries anticipated to strengthen and contribute to global economic recovery.Growth in US economy is projected to increase to 2.8% in 2014 from 1.9% registered during2013. Euro region is expected to turn the corner and achieve a growth rate of about 1.0%during 2014 though some countries among the region are expected to continue experiencingeconomic problems. In developing countries, economic growth is likely to continue with aprojected rate of 5.1% in 2014 as against 4.7% in 2013, with China’s GDP registeringa growth of 7.5%.

The Indian Economy recorded a growth rate of 4.7% in 2013-14, a sub five percent growthfor the second consecutive year. The agriculture sector, forestry and fishing sectorsregistered a growth rate of 4.7% in 2013-14 as compared to 1.4% growth rate in 2012-13,whereas the manufacturing and mining sectors experienced a negative growth during theyear. But with many new initiatives, being taken to improve economic growth andinfrastructure development through new investments, Indian economy, especiallymanufacturing sector, is expected to grow significantly during 2014-15, with focus onefficiency in implementation of projects and consequent employment generation. It isexpected that India will achieve a growth rate of 5.4% to 5.9% in 2014-15, which augurswell for the energy sector providing impetus for growth.

The challenge of controlling inflation continued to trouble the Indian economy duringthe year with the retail inflation high at 9.7% at the end of March 2014. However,significant improvement has been achieved in Wholesale Price Index (WPI), which wasreduced to around 6% as on March 2014 as compared to the average of 7.4% in 2012-13. Withthe Government focusing on elimination of supply-side constraints, especially the fooditems, the retail inflation is expected to come down to 6% in near future, which in turnwill contribute to strong economic growth. The Current Account Deficit (CAD), a keyindicator of country’s external vulnerability, which impacted the Indian currencyduring the first half of 2013-14, has been brought under control by taking a number ofmeasures. The volatility in the foreign exchange rate has been reduced and Indian currencyhas recovered substantially, easing the pressure on domestic prices of products that arebased on imports.

Energy Scene

The global demand for primary energy is projected to increase at an average rate of1.5% per annum in the near future. Oil continues to be the main energy source followed byCoal and Natural Gas, which is likely to grow faster than Oil. Also, the market share ofRenewable sources of energy is expected to increase in the coming years with continuationof incentives by State Governments and the Central Government.

Chennai Petroleum Corporation Limited

In line with the expected global economic trends in future, energy growth is likely totake place in developing countries, contributing almost 95% of projected global additionalenergy demand. Energy consumption in developing countries is estimated to increase at 2.3%per annum whereas in advanced countries, the energy growth rate is projected at 0.2% p.aupto 2035. It is anticipated that energy consumption in China and India will propel theglobal demand for energy, as the industrialization in these two countries will expandsignificantly in the next two decades, to meet the rising expectations of people in thesetwo countries. Primary energy consumption by industries will continue to be the dominantdriver for energy demand growth, accounting for about 50% of the growth, followed byenergy needs of residential, services, agriculture and transport sectors.

With the advent of shale gas and tight oil production, mostly from US, as a result oftechnological developments in the oil industry, US, instead of net energy importer, islikely to become net exporter of energy by 2018, which will change global oil tradingrelationships, with Asia’s increasing demand for energy import. Expected productionof energy from tar sands in Canada will also increase the global oil supply and may becomea good source of energy.

India continues to depend on imports to meet its ever expanding energy needs. During2013-14, the country imported 189.2 Million Metric Tonnes (MMT) of crude as compared to184.8 MMT in 2012-13. Due to relatively subdued prices of crude oil prices during theyear, the foreign exchange outgo on crude oil imports was $142.96 billion as against$144.3 billion in the previous year. The average crude oil price of Indian basket ofcrudes has come down from $107.97/barrel in 2012-13 to $ 105.52 /bbl in 2013-14 as perdata from Petroleum Planning & Analysis Cell. The global prices of crude oil depend onmany factors and are not expected to reduce substantially during 2014-15, as geo-politicalfactors continue to disrupt crude oil production from some countries.

Refining Industry and Oil Market Developments

The global oil consumption is projected to grow from the present level of about 90Million Barrels per day (MBD) and reach 109 MBD by 2035. The consumption of oil inadvanced economies is expected to decrease to a level of 38 MBD, while consumption bydeveloping countries is expected to reach 71 MBD, by 2035. In line with the increase indemand for oil, refining capacity is anticipated to increase at a similar pace.

The growth in petroleum products consumption in India during 2013-14 was the lowest inthe last decade with 0.7% increase over the previous year. Major petroleum products likeDiesel, Naphtha, Kerosene, Fuel Oil & LSHS and Lubricants registered negative growth.Petroleum products which recorded positive growth rate include Motor Gasoline (8.8%),Aviation Turbine Fuel (4.4%) and Petroleum Coke (15%). The overall demand for petroleumproducts in India increased from 157.1 MMT in 2012-13 to 158.2 MMT in 2013-14.

Indian refineries have processed more crude during 2013-14 at 222.4 MMT as against218.8 MMT in 2012-13, improving the capacity utilization further.

Opportunities and Challenges

India has been identified as one of the major developing nations, next to China , thatwill drive the energy consumption in the global market with expected massiveindustrialization to improve quality of life of its population. With many policyinitiatives in pipeline and envisaged investments in infrastructure development, thedemand for petroleum products will increase in the near future. To meet ever increasingdemand for petroleum products that are required to sustain the economic growth,investments in Petroleum Refineries are needed , either through expansion of existingrefineries or by setting up gross root refineries. With the global oil consumptionprojected to reach 109 MBD by 2035, the demand for petroleum products is also expected toincrease, which offers tremendous scope for new investments in refineries, crude &product pipelines and marketing infrastructure.

The demand for Natural Gas continues to outstrip domestic supply, indicating continueddependence on import of Liquefied Natural Gas (LNG) from other countries. Though prices ofLNG in the international market hardened in the recent years, demand for LNG in India willcontinue to increase, since growing Indian economy needs energy which is much cleanercompared to coal or Oil. The increasing need for Compressed Natural Gas (CNG) astransportation fuel for better environment conditions in major cities and towns andNatural Gas being a much cleaner fuel and environment friendly, will contribute to rise inusage of LNG.

CPCL has signed an Heads of Agreement with IOCL to supply LNG from the proposed 5.0MMTPA LNG facility at Ennore, Chennai.

With increased industrialization in future and to meet energy needs of risingpopulation, Power is likely to become a major source of energy for which demand willincrease. CPCL is currently implementing Resid project with a investment of Rs.3110 crore,which will become operational in 2015-16 and produce about 6.5 lakh tonnes of pet-cokethat can be utilized for producing power. Various technological options are being examinedby CPCL to generate much needed power that can add value to the bottom line of thecompany.

CPCL continuously pursues avenues to improve energy efficiency in operations ofexisting refineries and a number of energy conservation initiatives are underimplementation, resulting in saving of precious fuel that will enhance profitability ofthe company. Besides, it will indirectly reduce the carbon foot-print in and aroundrefinery, benefitting the environment. In addition, the company also is taking number ofsteps to reduce water consumption including reduction of steam consumption by closemonitoring of steam trap management system.

While CPCL has achieved excellent physical performance and incurred lower operatingexpenditure, the financial performance continues to be a major challenge due to number ofexternal factors, especially impact of the foreign exchange fluctuation on gross refinerymargins and inventory loss during the year. As part of efforts to improve profitability ofthe company, CPCL has developed various strategies to reduce crude inventory levels,strengthen operational reliability systems, and to implement cost reduction measures.Focussed communication programs have been conducted to sensitize all employees to issuesbeing faced by the company and ensuring their active participation in rejuvenating theorganisation to higher levels of performance.

Risks and Concerns

CPCL monitors risks facing the company through a well defined Risk-Management policyframework and develops and implements action plans to mitigate the identified risksthrough well coordinated efforts. These risks include wide fluctuations in ForeignExchange rates, restrictions on oil imports from Iran, safety & security and Increasein Interest rates, which are discussed in the following paragraphs.

a) Fluctuations in Foreign Exchange:

Indian rupee depreciated by about 11.75% during the year 2013-14 against US dollar,affecting the corporation’s financial performance specifically in view of huge crudeimport dependence. However, during the year 2014-15 till date, the fluctuations have beenminimal which will reduce the risk of impact on company’s profitability.

b) Restrictions on Oil imports from Iran:

Due to restrictions on oil imports from Iran on account of international factors, CPCLis unable to import crude from Iran, which is available with a credit period of threemonths as against one month of credit period offered by other crude exporting nations. Asa result, the working capital requirement of the company has increased, resulting inhigher interest expenses. With the expected easing of restrictions on Iran, CPCL canconsider resuming of oil imports from Iran in near future.

c) Safety & Security:

Petroleum industry being very sensitive to safety and security related issues, utmostcare is taken to ensure strict adherence to compliance of safety procedures with activeparticipation from employees and project contractors. Regular safety audits by variousteams including external agencies are undertaken at periodic intervals and theirobservations and recommendations are implemented with timeline targets. During the year,CPCL has implemented HVLR systems based on latest technology, to enhance the fire fightingcapabilities in the event of any major fire. As regards security risks, close monitoringof security arrangements is being done with focus on security drills and strictimplementation of recommendations of statutory agencies.

d) Increase in Interest Cost

The retail inflation continues to remain a concern for the economy which results insustenance of elevated interest rate scenario. High interest rate will have a significantimpact on interest cost for the company. To mitigate the high interest rate risk, companyhas adopted a judicious mix of long term and short-term loans to finance the projectexpenditure and working capital requirement. Foreign currency loans are availed wheneverthe all inclusive rate including hedging cost is more economical than Indian Rupee loansto the extent of export obligations.

Internal Control Systems and their Adequacy

Your Company ensures that adequate Internal Control Systems are in place to protect theinterests of the company. The internal control systems are continuously reviewed by theCompany to ensure that the objectives of the system are achieved.

Your Company has an Internal Audit Department with qualified personnel to carry outaudits covering various areas of operations. Significant audit findings, Replies toGovernment audit paras, Internal Audit Plan are periodically reviewed by the AuditCommittee.

Financial Performance

The Directors’ Report has adequately dealt with this subject.

Operational Performance

The Directors’ Report has adequately dealt with this subject.

Material Developments and Human Resources / Industrial Relations

The Directors’ Report has adequately dealt with this subject.

Cautionary Statement

Statements in the Management’s Discussion and 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.