Other Aspects Of APM

Importation and exportation

At present, based on the demand supply position and the macro economic needs, the Government of India permits import/ export of APM Products. Normally, HSD, SKO, LPG & FO are in shortage and naphtha is in excess. In the year 1995-96, as per MOP & NG estimates, the total imports were Rs125bn while exports were Rs16bn.

Wherever the Government of India decides that the shortage be bridged by imports, oil companies import these products through IOC. The difference between the landed cost of imports and ex-refinery price shall be adjusted in the Pool a/c.

Similarly in the case of exports, the net realisation as reduced by the marketing margin of the respective oil company & the ex-refinery price of the product, is adjusted in the Pool a/c. At present, these exports are routed through IOC and 50% of the marketing margin is retained by IOC.

Miscellaneous income

A major portion of miscellaneous income earned by oil companies consists of income from investment of surplus funds, interest on loans given to employees, fee received from other oil companies for providing hospitality, license fee recovery, and sale of scrap.

Since investments in money market instruments is not treated as a part of capital employed, it is but logical that income earned thereon is not reckoned under the APM. All other income related to operations covered under the APM, are either adjusted while computing the retention price, or separately surrendered to Pool account.

Surcharges recovered through Price & Cross-Subsidization of Products

Surcharges

As we have seen above, in addition to claims/ surrenders that are self-balancing, oil companies are entitled to several other claims like crude oil price differential, imported product price differential, differential freight etc. The oil pool has to generate funds to meet these claims and the same is done through levy of surcharges as detailed below.

• Cost & Freight surcharge (C&F sch)
• Freight surcharge pool surcharge (FSP sch)
• Retail pump outlet surcharge (RPO sch)
• State surcharge (ST sch)

An amount of Rs640/ mt/ kl is recovered as C&F surcharge in the price of all formula products. In the case of free trade products marketed by the oil companies the same shall be#included in the transfer price of the product or in the transfer price of feed/ fuel, as the case may be.

An amount of Rs40/ mt/ kl is recovered as FSP surcharge in the price of all formula products to cover various freight / transportation claims of oil companies.

An RPO surcharge of Rs60/ kl of MS and Rs20/ kl of HSD is recovered through price to cover the differential commission to be paid to dealers/ distributors.

A phenomenon, which developed in the late 80's, was levy of non-recoverable sales & turnover taxes by states. To recover these taxes, a surcharge is recovered on various products and this surcharge varies from state to state and also within a state from product to product. The surcharges are worked out in such a manner that the under-recoveries of all the oil companies in a state are fully recompensed.

It may be noted that the key reason for recovery of surcharges and allowing claims against the same is to enable uniformity & stability of prices.

In addition to these surcharges, the Government of India tries to achieve its objective of ensuring availability of certain products at subsidized rates for weaker sections of the society and priority sectors in the industry through cross-subsidization of products. The cross subsidization is done through product price adjustment (PPA) by which a higher PPA is recovered from products which can bear the loading and a lower or a negative PPA is recovered/ reduced from the price of products which are to be subsidized. At present SKO & LPG supplied to domestic consumers and naphtha, LSHS & FO supplied to Fertilizer units are subsidized through a lower / negative PPA. The bulk of this subsidy is borne by MS, ATF (domestic airlines), LPG (other than domestic), naphtha, FO & LSHS supplied to other than Fertilizer units. The details of product-wise PPA are given.

Product Price Adjustment

These patterns are based on national/ regional demands, logistics of transportation, and co-ordination of the transportation arrangements for crude imports/ coastal movements.

The major pool accounts currently being maintained by OCC are

Crude Oil Price Equalization account (COPE)

The difference between the actual FOB cost of crude and the weighted average pooled FOB price#included in retention price shall be adjusted in this account.

Cost & freight adjustment account (C&F)

Against the Rs640/ SU recovered through selling price of formula products/ transfer price of feedstock for free trade products, oil companies are permitted to adjust the following.

• Variation in crude oil cost element
• Difference in ex-refinery / transfer price vis-à-vis retention price
• Product pattern variation & incentive claims
• Variation in cost of bitumen drum steel and excise duty thereon
• Variations in entitlements of LPG / bitumen filling charges
• Variations in landing cost of imported formula products vis-à-vis ex-refinery price
• Variations in price realized on export of formula products (net of marketing margins) vis-à-vis ex-refinery price
• Price/ exchange variation on sale of ATF/ bunkers to foreign airlines/ vessels
• Variations in retention marketing margins/ RPO & airfield charge as against the weighted average#included in price
• LPG under/ over recoveries including the cost of transportation of bulk LPG from refineries to bottling plants, transportation of packed cylinders to markets
• Cost escalation claims, wherever permissible
• Return on incremental networth on a year to year basis, subject to final adjustment
• Demurrages with approval of OCC
• Difference between the actual freight and NRF from pricing point to the distribution point.
• Subsidy on supply of SKO / LPG to hilly areas.
• Exchange rate variation on Euro Dollar loans taken by IOC for suppliers credit for import of crude oil / products.
• Temperature variation allowance given to customers for hot loading of MS, HSD, FO, SKO and LDO at refinery points.
• Adventitious gains arising due to revision in retention price/ ex-refinery price/ increases in rail freight.
• Other adjustments, which may be notified by MOP & NG from time to time.

Product price adjustment (PPA)

The fixation of final selling price is done through variation in PPA and this element is surrendered/ claimed by oil companies.

Freight surcharge pool account (FSP)

Against the surcharge of Rs40/ SU of formula products surrendered by oil companies, oil companies make the following adjustments

• Cost variations on coastal movement of products.
• Cost variations through rail/ road bridging for out-of-zone movements with specific authorization from OCC.
• Variations in NRF and pipeline transportation cost.

Sales tax surcharge account (STS)

Oil companies surrender the surcharge to OCC and claim all under-recoveries on account of CST/ irrecoverable sales taxes.

Self-balancing

It may be noted that all these accounts were originally conceived and surcharges fixed in a way that each of these accounts are self-balancing and end as a zero sum account. But the accounts have rarely self-balanced due to the following reasons.

• Variations in landed cost of crude/ imported products on a sustained basis either due to fluctuations in prices or due to depreciation of rupee or due to changes in customs duty without correspondingly changing the pooled FOB price/ final selling prices.
• It may be noted that the current pooled FOB price of crude was fixed in 1986 though the landed cost of crude has significantly increased. It is estimated that if the COPE account is to be self-balancing the pooled FOB Price should be close to Rs4300/ mt as against the current price of Rs1700/ mt.
• Non-revision of surcharges recovered to compensate for certain costs for long periods of time, even though the costs have increased over such period of time.
• Ad-hoc increases/ decreases in PPA for achieving socio-economic objectives of the Government of the day.

This results in deficits/ surpluses to each of these accounts and cumulatively to the oil pool account. The oil pool generated huge surpluses in the mid-eighties when the international oil prices were soft, these surpluses were merged by the consecutive Governments, to the consolidated fund of India. Since the early 1990's the growth consumption of petroleum products has been very high and due to distortion in final product prices, the consumption pattern has changed. In addition, international oil prices have been very firm since the last couple of years while the rupee has weakened by more than 10% in the last quarter of 1995. Due to political expediency, no decision was taken to pass on the costs till July '96, even the increases effected in July '96 are highly insufficient to cover the present day costs. The deficit of oil pool account is therefore ballooning with consequent impact on the bottom-line of oil companies. It is estimated that the year end deficit would be over Rs150bn.

Due to variation in recognizing the claims, specially the arrears of margins, due from OCC, the profitability of oil companies from year to year is very difficult. The problem compounds when large claims like refinery incentive claims pertaining to more than one year is recognized by oil companies in one year. Since all claims are recognized in books only after in-principle approval from OCC, the claims for the said period may be booked by various companies at varying points in time. To the extent that the lodging of these claims can be postponed, leverage is available to the oil companies to postpone recognition of incomes.

The price build-up of formula products consists of the following elements.

Build-up up to the ex-storage point - all products

Ex-Refinery Price ® 1

+

Excise Duty ® 2

+

Industry Marketing Margin ® 3

+

C &F Surcharge ® 4

+

FSP Surcharge ® 5

+

PPA ® 6

+

State surcharge ® 7

+

Filling charges (for LPG / bitumen) ® 8

+

Drum / excise on Drum / packing (for Bitumen/Wax) ® 9

=

Ex-storage price ® 10

Build-up of delivered products - MS / HSD / ATF

Ex-storage price ® 10

+

RPO / airfield charges ® 11

+

RPO surcharge ® 12

+

PPA on RPO / AFS ® 13

=

Price to dealer / airline ® 14

+

Dealers/ distributors commission ® 15

=

Ex-RPO/ AFS price ® 16

• Ex-refinery price is weighted average retention price of all refineries prorated over various products as per certain indices plus Rs.25/ su.

• Excise duty is calculated on the final selling price on advalorem basis. At present excise duty on the petroleum products is 15% and only 10% is#included in the selling price. Balance 5% is to be adjusted in the Pool a/c.

• Weighted average marketing margin of all the marketing companies is#included in the selling price. Marketing Margin consists of common & specific cost reimbursement and return on capital employed. Differential between the retention margin of each of the oil companies and the marketing margin#included in selling price shall be adjusted in the Pool a/c.

• C&F surcharge is Rs640/ SU to be surrendered by the oil companies on sale of product.

• FSP surcharge is Rs40/ SU to be surrendered by the oil companies on sale of product.

• PPA is the element introduced to enable cross subsidization. For certain products, PPA is very high and for certain others, it is either low or negative. PPA is surrendered/ claimed in to from Pool a/c on sale of product.

• State surcharge varies from product to product and state to state, depending upon the CST/ irrecoverable sales taxes in the respective states.

• Weighted average filling margins (WAFM) of the industry. Difference between retention margin and WAFM to be adjusted in the Pool a/c. For all purchases ex-refinery bottling plants, marketing companies to pay the differential between the WAFM and the margins paid to refineries.

• Weighted average drum cost which#includes steel & fabrication cost of drums and excise duty thereon for bitumen (pkd) and packing charges for wax. Variation in steel cost and excise duties to be adjusted in the Pool a/c.

• Ex-storage price is at the refinery point. For up-country centers, notional rail freights from the nearest refinery to be added, irrespective of the mode or source of supply. Differential transportation cost to be adjusted in the Pool a/c. In the case of non-delivered products, applicable sales tax, and local levies to be added extra.

• RPO / AFS charge consists of delivery charges of Rs7/ kl for FDZ of 39 km for MS/ HSD & Rs9/ kl for ATF, industry weighted average of common costs / return on investment in RPOs / AFS. Difference between the retention RPO/ AFS charge vis-à-vis the industry average#included in price to be adjusted in the Pool a/c.

• RPO surcharge of Rs60/ kl of MS and Rs20/ kl of HSD to be surrendered by oil companies on sale.

• PPA on RPO/ AFS always negatives to reduce the price differential between ex-storage price and RPO/ airfield Price.

• Price to the dealer within FDZ of primary pricing point. For deliveries beyond FDZ, 18 paise per kl/ km to be added to the price of MS/ HSD and 7 paise per kl/km to be claimed from Pool a/c after sale.

• Uniform dealers' commission of Rs80/ kl of MS and Rs40/ kl of HSD. The actual dealer's commission is calculated on a different basis and the difference between the dealer's commission paid and the uniform amount so recovered to be adjusted in the Pool a/c.

• Final RPO/ AFS price. Sales tax, local levies to be added to arrive at the final consumer price.

On the positive side APM has ensured

• an orderly growth of the oil industry
• continuous availability of products to consumers at fairly stable prices
• continuous availability of crude to refiners
• avoidance of wasteful duplication & redundancy of infrastructure facilities
• achievement of socio-economic objectives of the government

However, in spite of the penalties and rewards which was built into the system, the cost-plus formula has failed miserably to create a globally competitive oil industry and has instead created oligopolies by guaranteed profitability. APM has had unintended effects which can be summarized as under

Oil Pricing has been used as a tool for achievement of objectives of the government of the day, as divorced from underlying economic realities. The prices of politically sensitive products do not reflect the economic cost of the products. Subsidies and cross-subsidies have resulted in wide distortion in consumer prices and consumption pattern of petroleum products including dieselisation of Indian economy. In case of highly subsidized products, the low pricing much below its economic value has led to inefficient, wasteful use resulting in sub-optimal inter-fuel substitution.

Political compulsions often dictate price administration and pricing system is thus inflexible to changes in global prices. In a country where more than 50% of the demand is met through import of crude oil/ products, such inflexibility can result in hazardous consequences. The pool deficit as on March 31, 1996 was more than Rs50bn and as on March 31,1997 it is likely to balloon to Rs150bn. Obviously this situation cannot be allowed to continue for long.

Since return is provided on capital employed, there is no guarantee that the facilities put up by the oil companies are being used in the most productive manner. APM provides little incentive for cost minimization, technological upgradation and improved productivity. In fact, the refineries have an inherent fear that any attempt to increase crude throughput could result in an increase in standards that could effectively turn out to be a penalty for being more productive. SPE scheme has stifled market competition and has resulted in marketing companies being used as mere distribution channels. APM has thus failed to create a consumer friendly and internationally competitive vibrant petroleum industry.

With the opening of the economy since 1991, the situation in the country has also dramatically changed. The demand for petroleum products have doubled, the investment requirements in the sector have substantially grown, the refining sector has been opened up, parallel marketers have been permitted to market select products and the need for attracting private capital and foreign direct investment for creation of globally competitive industry.