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| India Infoline Sector Reports | Wed, 18-Feb-2004 16:16:31 IST (GMT+5:30) | |
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Administered PricingMechanism Evolution Of APM Up to 1939, there were no controlswhatsoever on the pricing of petroleum products. Between 1939 and 1948, the oil companiesthemselves maintained pool accounts for major products without any intervention by thegovernment. In 1948, an attempt was made to regulate prices through Valued Stock accountprocedure. Under this procedure realization of oil companies was restricted to the importparity price of finished goods (with Ras Tanura as the basing point), plus excise duties/local taxes/ dealer margins and agreed marketing margins of each of the refineries. Anyexcess realization was surrendered to the Government. The Shantilal Shah committee, set upin 1969, did not favor the import parity price being set as a benchmark for domesticpricing as domestic refining capacity had significantly increased by then. In 1976, theOil Pricing Committee (OPC) recommended the discontinuance of the import parity principleon the following grounds About 90% of the total demand of POLproducts were met by indigenous production and no major shortfall was anticipated. Prices of finished products and crude oildid not necessarily move in tandem. Import parity did not take into accountinter refinery differences in terms of product pattern, type of crude used, location andscale differences. The structure of West Asian product prices,which was the basis of determining prices in India, did not necessarily reflect the costpattern and operations of Indian refineries. The OPC therefore suggested that thedomestic cost of production should be the determining factor for pricing of petroleumproducts. The present day APM was evolved on the recommendation of the OPC and came intoexistence on December 16, 1977. The smooth implementation of APM was possible, as by then,all the foreign oil companies were acquired by the Government of India. Rationale For APM One of the important drawbacks of theimport parity pricing was that the indigenous cost of production was totally overlookedwhile determining producer prices. This issue was addressed through Retention PricingMechanism, by which refiners were allowed to "retain" out of the sale proceeds, · Cost of crude · Refining cost and · Reasonable return on investment. The same mechanism was extended tomarketing & distribution companies as well. The Government of India also fixed thepricing of finished products and the returns of oil companies were de-linked from theprice at which the goods were finally sold. With the administration of pricing of productsby the government, the retention mechanism also came to be known as the AdministeredPricing Mechanism or APM. The scheme is administered under the aegisof the Ministry of Petroleum & Natural Gas through its executive wing "OilCo-ordination Committee" (OCC) with its secretariat at New Delhi. Objectives Of APM To optimize the utilization of refining andmarketing infrastructure by treating the facilities of all the oil companies as commonindustry infrastructure, the access of which would be available to all the oil companiesby hospitality arrangements, thus eliminating wasteful duplication of investment. To make available all products at uniformprice ex-all refineries so as to minimize cross-haulage of products & associatedenergy costs. To ensure continuous availability ofproducts/ crude to refiners by recognizing import needs wherever there are deficits inindigenous production. To ensure that the returns to oil companiesare reasonable, in line with operational efficiencies as also generation of sufficientresources to enable industry to setup facilities to meet the growing needs. To ensure stable prices by insulatingdomestic market from the volatility of prices in the international market. To achieve socio-economic objectives of theGovernment by ensuring availability of certain products at subsidized rates for weakersections of the society and priority sectors in the industry through cross-subsidizationof products. Functioning Of APM Basic principles The basic principles on which the edificeof APM has been built could be summarized as under. Raw materials are made available at apre-determined fixed price at the manufacturing point (Delivered Cost of Crude) on asustained & continuous basis to refiners. Similarly, finished products are madeavailable to marketing companies at pre-determined prices (Ex-refinery prices). Refining/ conversion/ marketing costs arereimbursed as per certain pre-determined criteria. Compensation for investments in fixedassets and working capital is given as per laid down norms. Rewards and Penalties are built into thesystem to encourage efficiency. Classification of products under APM Currently, the products marketed by oilcompanies in India are categorized as follows Formula products - governed by APM. Free trade products - outside the purviewof APM. Retention Price The oil companies are reimbursed inaddition to the cost of crude oil
OCC undertakes a cost updation study ofeach of the oil companies, once every three years this three year period is called thePricing Period. The last Pricing period expired on March 31, 1996 and the current pricingperiod has commenced on April 1, 1996. The first year in the pricing period is called thebase year. The exercise is normally undertaken in the middle of the pricing period andcompleted at the end of the pricing period. The costs incurred during the said period,including projections for the pricing cycle, is collated for each of the oil companies andad-hoc margins are worked out first and thereafter replaced by final margins. It may benoted that not all costs are reimbursed and the expert committee of OCC moderates theactual costs. The margins for the pricing period is worked out by prorating the aggregatecosts over the standard throughput/ sales volumes as per sales plan entitlement (SPE) toarrive at operating cost per unit. The operating cost so arrived will be static during thepricing period excepting for the following escalations which are considered forreimbursement on the merits of each case. · Increases in salaries/ wages arising onaccount of Long-Term Settlements (LTS). · Increase in direct variable costs vizchemicals, catalysts and utilities (purchased power & water) over the cost consideredin the base year. · Increases in rentals payable torailways/ statutory Bodies over the cost considered in the base year · Increases in CISF expenses over the costconsidered in the base year It may be noted that in practice, theactual costs recovered by oil companies may not match with the estimated costs consideredin the cost updation because of the following reasons: · the actual costs are dynamic & notstatic over the pricing period · not all expenses are fully reimbursed byOCC (*) · the actual performance may be differentfrom the standards · the actual costs may not be in line withthe norms Obviously, such unavoidable variations incost actually incurred and the cost recovered/ reimbursed would have a direct bearing onthe Profit & Loss account of the oil companies (Refer discussion on Incentives &Penalties) (*)The following expenses are notreimbursed under APM · Bonus / ex-gratia in excess of thestatutory limit · Donations & charities · Bad debts/ provision for doubtful debts · Loss / gain on disposal of assets The major heads of expenditure ofrefineries and marketing companies are · Chemicals & catalysts · Consumables, power & utilities · Repairs & maintenance · Depreciation · Salaries & wages · Product losses · Overheads Depreciation is worked out at the ratesprescribed by the Companies Act, 1956 on straight-line basis for assets commissioned afterApril 1,1983 and on WDV basis for assets commissioned prior to April 1,1983. Depreciationis computed on pro-rata basis for assets commissioned during the year. However, whileworking out the margins large capitalization involving substantial changes in productpattern, standard throughput etc are considered only as and when these projects arecommissioned. It may also be noted that bonus/ ex-gratiapaid to employees is not considered as a part of cost but as a part of the return andreimbursed along with return on capital employed at a ceiling of 8.33% of the annualwages.
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