Variation In Gross Margins

Unlike others, in the case of oil industry gross margins are not comparable from year to year as gross margin is a function of tax rate and with increases or decreases in tax rates, the gross margin varies. For eg at a tax rate of 51.75%, the pre-tax return on networth was 24.87% and at a tax rate of 35%, the pre-tax return works out to 18.46%. The gross profit ratio gets more complicated with earnings of previous year accounted in current year.

In our opinion the gross margins of oil companies are not comparable from year to year. Conclusions drawn from such comparison could be misleading and incorrect.

Fuel Refinery

Standards are laid down for each refinery in respect of throughput, product pattern, fuel & loss. The standard throughput is fixed after taking into account the crude availability, the primary/ secondary/ offsite facilities, intake capacity and other technical factors. For a new refinery, the standard shall be 60% of the installed capacity in the first year of operation and 90% in the second year of operation.

Based on the aggregate operating cost (OC) and return on capital employed (ROCE) standards so set, the OC and ROCE per unit of crude throughput is worked out for each of the refineries, for the relevant pricing period.

The Delivered Cost of Crude (DCC) is worked out for each of the refineries. DCC consists of Pooled FOB cost of crude, freight, insurance, ocean loss, and wharfage/ other landing charges and customs duty.

Whereas the Pooled FOB price of crude is uniform at Rs1700/ mt for all the oil companies, the other elements of DCC are not uniform as these would depend on the proportion of indigenous & imported crude and location of the refineries.

The difference between the landed cost of crude and the DCC can be claimed from the Pool a/c, subject to the following restrictions.

• Actual cost of insurance shall be limited to a maximum premia based on free particular average clause including war risk premia.
• Ocean loss for imported crude shall be taken as 0.5% of the bill of lading quantity, 0.2%/ 0.3% of Bombay High custody transfer quantity by West Coast / East Coast refineries. Variation in actual quantity of losses vis-à-vis the norms shall benefit or adversely affect the refineries.

The retention price per mt of crude for each of the refineries is thereafter worked out by cumulating the DCC, the operating cost (OC) and the ROCE. While working out the operating cost, the following amounts are reduced as the same is recovered from the marketing companies separately in addition to the ex-refinery prices.

• Rs50/ mt of LPG filled in bulk.
• Rs200/ mt of LPG filled in packed cylinders.
• Rs50/ mt of Bitumen filled.

The total amount of reduction is worked out by multiplying the aforementioned rates with the standards set for the pricing period.

The retention price per mt of crude so computed is prorated over various products, as laid down in the standard product pattern through a set of indices laid down by OCRC. While calculating the retention prices of the products, the cost of fuel & loss is spread over all the products. The list of the indices based on which the allocation is done is given in table 8. These indices have been developed after taking note of current supply & demand position. Prevailing international prices of various petroleum products, need to encourage production of deficit products and to discourage production of surplus products and other factors affecting the distribution and allocation efficiency. The role of the indices is limited for determination of product prices of refineries, this has little bearing on the final consumer prices.

The retention price per mt of product is worked out as per the following formula

(RPPMT of Crude x Standard crude throughput) x Index of each product

SKO equivalent of total production

Where, SKO equivalent of total production = å (Standard production of each product x Index of each product)

In effect, the resultant product of RPPMT of crude & standard crude throughput would be equal to the product of RPPMT of each product & standard production of the product as#included in SPP. Illustrative workings for BPCL for the period 1990-93 is given in table

The weighted average retention prices of each of the products of all the refineries together is worked and the same is converted into respective selling units by adopting mt/ kl conversion factors. An amount of Rs25/ su is added to the computed average to arrive at the ex-refinery price. The addition of Rs25/ su is made to avoid the necessity of frequent revisions in the ex-refinery price on account of variations in the cost elements of DCC (other than the FOB cost of crude oil). All the refineries will sell/ transfer the products to marketing companies at ex-refinery prices on a uniform basis. The difference between retention price and the ex-refinery price will be adjusted in the Pool a/c.

The present ex-refinery prices however do not reflect the weighted average retention prices, as they have not been revised since 1986.

As retention prices have been worked out on the basis of standard crude throughput and standard product pattern, any variation in either of them arising out of variations in crude mix/ government directives would have significant bearing on the profit & loss account of oil companies. In order to insulate the oil companies, from these variations, the refineries are entitled to adjust the differences in realization arising due to variations in product pattern from the standard in the Pool a/c. Thus, any shortfall can be claimed from Pool a/c and any surplus is to be credited to the Pool a/c.

The refineries therefore carry out the following adjustments with the Pool a/c.

• Differential between the FOB cost of crude as against the pooled FOB price.
• Differential between the various cost elements in DCC as against the actual costs.
• Difference between the retention price and the ex-refinery price based on actual production.
• Differences in realization arising due to variations in product pattern - Actual vis-à-vis the standard as multiplied by the retention price

IOC, Digboi and MRL are two refineries that have wax sector with a total standard capacity of 56 tmtpa. The feedstock for wax is equal to the retention price considered in the product pattern and further processing cost & return on investment is paid to the wax refiners in line with the processes laid down for fuel refineries.

At present, Lube Oil Base Stocks (LOBS) are produced in the following lube refineries

• HPCL, Mumbai with a capacity of 335 tmtpa
• MRL, Chennai with a capacity of 270 tmtpa
• IOC, Haldia with a capacity of 183 tmtpa

In line with the principles adopted for fuel refinery, standards are laid down for throughput, fuel loss and product pattern. Operating costs and return on capital employed are also worked out to compute the retention price per mt of throughput. The cost of reduced crude, which is the feedstock for manufacture of LOBS, is equal to the retention price of the LOBS feed as per the formula worked out for the respective fuel refinery.

The grade-wise retention price per mt of Lube Base stock is thereafter worked out based on a set of indices. The allocation of the base retention price of LOBS feed is done in the same manner as being done for fuel refinery. Lube refineries shall sell the lube base stock at the transfer price, which will be determined by OCC every quarter, on an import parity basis.

The difference between the transfer price and retention price shall be surrendered to or claimed from pool a/c.

Marketing of petroleum products is done by oil companies through a network of storage & distribution facilities which#include installations, depots, LPG bottling plants, airfield stations (AFS), retail pump outlets (RPOs) and sales offices spread across the country.

A major portion of MS, HSD & ATF are sold ex-RPOs/ AFS and all other products are sold ex-storage points (mainly installations). The margins for all products are first computed up to the ex-storage point stage and in respect of MS, HSD & ATF, margin is computed separately to cover the cost/ return on investments in RPO/ AFS.

The operating costs to be reimbursed up to the ex-storage level are broken up as under.

• Installation cost
• Distribution cost
• Administration cost

The installation & distribution cost are further broken up into common costs and specific costs.

Specific costs represent the cost of product losses incurred at the installation and distribution stage and are determined as per the norms recommended by OCRC, given in table.

Specific costs are computed by multiplying the aforementioned percentages to the sum of ex-refinery price & excise duty of each product.

Specific costs are uniform for all the oil companies and therefore if any company is able to reduce its incidence of loss, it stands to gain. On the contrary, if the loss is more than the norm, the company stands to lose.

All operating costs other than specific costs are categorized as common costs. Since the common costs are bound to be different from one company to another, the actual reimbursement would differ from one company to another. In line with the procedure given in paragraph above on "Operating Costs", the allowable costs for the pricing period are collated and the total cost is prorated over SPE volumes to arrive at a per kl cost. Wherever the selling unit is mt, per mt cost by using conversion factors, is arrived.

In line with the procedure given above on "Return on Capital Employed", the return on capital employed up to the ex-storage stage is worked out. Whereas the NWC worked out on the basis of 30 days sale will vary from product to product, as ex-refinery price & excise duty will be different from product to product, the return on NFA will be uniform across the products excepting for kl/ mt conversions. Capital employed to the extent of networth would earn 12% post-tax return and balance if any would be treated as deemed borrowings on which weighted average cost of borrowings would be given.

The marketing margin at the ex-storage point would thus#include the installation, distribution (both specific & common) and administration costs and the return on capital employed and this would be the retention margin per selling unit. The weighted average marketing margin of all the oil companies is computed and#included in the selling price, and the oil companies would adjust the differential between the retention margin and the marketing margin#included in the selling price in the Pool a/c.

As stated earlier MS, HSD and ATF are delivered products, sold ex-RPOs/ AFS as the case may be. Additional cost is involved for transporting of these products to outlets from the storage points, for maintaining these stations and additional investments are made in infrastructure in these outlets. Compensation for common expenses incurred in maintenance of these outlets, delivery charges incurred and return on investment from these outlets is separately given. The sum of common cost, delivery charge and return is termed as RPO/AFS charge and it is#included in the retention margin of each of the oil company. The weighted average RPO/ AFS charge is#included in the price build-up for recovery from the consumer. While the procedure for computation of reimbursement for common expenses and return is nothing different from the procedure enunciated for sales ex-storage points, the principles for reimbursement for delivery charges needs elaboration.

In respect of a fixed delivery zone (FDZ) involving a round trip of 39 km from supply point (usually within city limits), a fixed delivery charge of Rs7/ kl is recovered for MS/ HSD and the same is#included in the RPO retention margin of all the oil companies. For supplies beyond the FDZ, an amount of 18 paise per kl/ km is recovered from the consumers in addition to the FDZ price. The oil companies are allowed to claim a further sum of 7 paise per kl/ km in respect of sales of MS/ HSD, beyond FDZ. These rates were fixed by OCRC in 1984.

In respect of delivery of ATF to AFS, an amount of Rs9/ kl is built in the retention margin.

While calculating the RPO Charge, the "License Fee" (LFR) recovered from the dealers is taken into account and the common costs actually incurred by the oil companies stand reduced by that extent. LFR is a fee recovered by marketing oil companies so as to partially recover the cost of facilities provided at the RPOs.

The Government of India also regulates the commission payable to dealers. MOP & NG had done a detailed study on the compensation payable to dealers in 1993 and have evolved a formula for compensation to dealers for investment in working capital, evaporation losses and other fixed/ variable costs. For the limited purpose of calculating dealer's commission, the total sales volume is also broken into two slabs - Slab I covering sales up to 600 kl per month and Slab II covering sales more than 600 kl per month. The commission in Slab I is higher to enable the dealers to cover the fixed costs.

Dealer's commission changes

With any change in administered price of MS/ HSD.

On April 1, of each financial year to compensate for increase in cost due to inflation.

Formula for calculating dealer's commission

For change in price,

Cr = Co + [(Pr-Po) x F]/100

On April 1, of every year

Cr = Co x { 1 + F x[ (New AICPI - Old AICPI)/Old AICPI]}

where Cr = Revised Commission

Co = Old Commission

Pr = Revised Price

Po = Old Price

AICPI = All India consumer price index

F = Factor for MS Slab I=1.05, Slab II=0.68

for HSD Slab I=0.68, Slab II=0.34

It may however be noted that the average commission earned by the dealer is less than 2% of the sale price of the product, giving rise to adulteration with cheaper products like naphtha and kerosene.

Though commission due to dealers is varying, in order to maintain uniformity in selling prices, a sum of Rs80/ kl of MS and Rs40/ kl of HSD is recovered through the selling price. The differential between the actual entitlement of the dealers and the amount recovered through the selling price is paid to the dealers separately by the oil companies and recovered from the Pool a/c.

The pricing of MS/ HSD discussed above is in respect of refinery locations (also known as primary pricing points) and for supplies at the upcountry centers, notional rail freight (NRF) from the nearest refinery to the installation/ depot at the upcountry center is added. It may be noted that the actual cost of transportation of these products is different from the NRF, and the oil companies are allowed to adjust the difference in the Pool a/c. Further, it is likely that due to various reasons, the actual supply may take place from a point other than from the primary pricing point. These movements are known as out-of-zone movements and with due approval from OCC on a case-to-case basis, the differential cost can be adjusted in the Pool a/c.

The details of retention margins for the marketing companies as per the latest available pricing period is given in the chapter on Marketing & Distribution.

To promote orderly growth in the oil industry, the market share of each of the individual oil companies are controlled through sales plan entitlement (SPE). The market share of each company is pre-determined by the Government according to SPE Formula and for exceeding the share, there is a penalty that requires surrender of margins. The salient features of the schemes implemented from October 1,1989 are as follows.

• Product-wise SPE to be worked out based on SPE of the previous year.
• Effective April 1,1988, all the oil companies would be allowed a uniform growth rate.
• For actual sales in excess of SPE allocation, the resultant excess margin was to be shared between the concerned companies.
• Tankages, at depot would be in line with market participation. In respect of variation over 3% between market share and tankages, marketing margins would be suitably adjusted in the Pool a/c.

At present, BPCL & IBP surrender margins to OCC for sales beyond SPE and the amount so surrendered is distributed to IOC & HPC. The marketing companies therefore make the following adjustments with the Pool a/c.

Difference between the retention margin and the average marketing margin#included in the selling price.

• Difference in RPO charge#included in the retention margin and the RPO charge#included in the average marketing margin.
• Claim of 7 paise per kl/ km for MS/ HSD deliveries beyond FDZ.
• Difference between the actual freight and NRF for MS/ HSD supplied at upcountry centers and the differential transportation cost incurred on out-of-zone movements.
• Difference between the dealer's commission paid and the commission of
  Rs80/ kl of MS and Rs40/ kl of HSD recovered through price.
• Adjustments arising due to variation in sales vis-à-vis SPE.

The compensation mechanism for crude & product pipelines can be summarized as under

For crude pipeline, 100% of installed capacity/ standard throughput is taken as normative utilization capacity (NUC) except in the case of ONGC offshore pipeline where NUC is taken at 80% of installed capacity. In case a crude pipeline is newly established, NUC shall be taken at 70% of standard throughput for the first three years of operation.

For product pipelines, 95% of installed capacity/ standard throughput is taken as normative utilization capacity (NUC). In case a pipeline is newly established, NUC shall be taken at 70% of standard throughput for the first year of operation. NUC has been determined taking into account the demand at the various tap-off points and the constraints of storage capacities at these tap-off points.

NWC is taken as 30 days operating cost excluding depreciation.

NFA of the pipeline plus NWC as worked above would be the total capital employed (TCE). TCE, so far as related to networth, shall fetch 12% post-tax return and the balance shall be treated as deemed borrowings on which weighted average interest cost would be reimbursed.

Operating costs for the pricing period shall be reimbursed.

The retention margin per mt of throughput shall be the aggregate of TCE and operating costs as divided by NUC.

The difference between the retention margin and the NRF/ pipeline transportation cost recovered through selling price shall be adjusted in the Pool a/c.

Pipeline throughput in excess of NUC would get full compensation for the entire quantity.

LPG Filling, cylinder compensation & LPG pricing

Packed LPG is being marketed in cylinders of three sizes - 14.2 kg, 19 kg and 50 kg. While 14.2 kg cylinders are supplied for domestic consumers, the other two are for non-domestic consumers. The selling prices of LPG for domestic consumption are subsidized whereas, for other uses the selling price is determined on an import parity basis.

For each of the refineries, standard LPG filling norms is set. Details of filling norms for the pricing period 1990-93 is given in table 14. For all fillings up to the standard, each refinery would be entitled to a uniform filling margin of Rs200 per mt for packed LPG and Rs50/ mt for LPG sold in bulk. If LPG filling exceeds the standard, the refineries are eligible to retain Rs50/ mt of incremental LPG packed and the balance amount of
Rs150/ mt is surrendered to Pool a/c. There is no penalty however for not filling up to the standard.