Marketing Companies

The R-group has recommended deregulation of downstream marketing in Phase II and Phase III. Complete deregulation of the marketing sector is possible only if the issue of subsidies is fully addressed

Under the APM, sales plan entitlement of oil companies are pre-determined, selling prices of various products are uniform, companies are assured of supplies, appointment of dealers/distributors is beyond the control of the companies, dealers commission is fixed and a negligible portion of the freight differentials is passed on to the consumers. Supply infrastructure of each of the companies has been built in accordance with industry needs (and not in accordance with the needs of the company), intra-product margin differentials are insignificant and there is little incentive for competition. All these would slowly change with deregulation. The average GMMs constitute about 1% of selling price for MS to about 2.66% of selling price for HSD.

Marketing: Peculiar issues

Unlike the refining sector, the impact of deregulation of downstream marketing is quite uncertain due to the following reasons.

Effects of competition: Amidst competitive environment the marketing companies would need to make substantial investments in upgradation of marketing outlets in the creation of brand image. Advertisement costs are likely to increase, the commission payable to dealers/ distributors is likely to move up, and dealers / distributors may be given supplies on credit. We have witnessed all this in the lubricants sector.

Capex for upgradation of distribution infrastructure: Companies would be required to set up new distribution infrastructure in all locations where they are presently taking hospitality of other oil companies and this could mean large investments. It may also be noted that all these investments have to be made within the next 6 years that could be a tall order for all the companies. Though some hospitality arrangements may continue due to various compulsions, the companies utilizing these facilities would be required to pay market-related price. Since the SPE/ product sharing arrangements would be done away with, respective companies would have to arrange product availability in their markets and this could mean haulage of products and consequent transportation costs.

Re-alignment of markets: Due to various constraints of distribution infrastructure, product availability etc it may become unviable for some of the companies to be present in all markets and some re-alignment may take place, by which the companies may forego their share in unviable markets.

Cash generation from LPG (pkd): Currently the biggest cash cow for marketing companies is Packed LPG. As discussed in the chapter on APM, the cash generation is about Rs2 for every rupee spent. 100% cost of cylinders is reimbursed to the companies and the filling margins are extremely attractive. In our opinion, the cash generation could erode with deregulation.

Direct competition from refineries: In the case of bulk products like naphtha, FO, LSHS and bitumen, the refining companies may begin to market their products directly with large industrial consumers and this could result in severe erosion of market share of the marketing companies. The margins on these products are also likely to be under continuous pressure.

Fluctuating Marketing Margin: As prevalent internationally, the companies may not be in a position to change the prices of products, especially the retail products, in response to temporary fluctuations in landing prices of imported products/ transfer price of refineries. In countries where free market mechanism prevails, it has been noticed that though the trading prices of refined products change frequently, the retail selling prices do not fluctuate so frequently, and it is the marketing margin which fluctuates.

The GMMs earned by the marketing companies in a de-regulated scenario would thus critically depend on the strategies and focus of each of the companies and it would be very difficult, to quantify the earnings of the players in the downstream marketing. The integrated companies ie IOC, BPC and HPCL would however emerge stronger than simply refining and marketing companies.

The phased deregulation of oil and gas sector began on April 1,1998. Globally, crude oil prices have been under tremendous pressure due to falling demand particularly in the Asian region. Refining margins have also fallen considerably in the region. Average refining margins in Singapore were US$1.5/ bbl in Q2 1998, as against US$2.3/ bbl in 1997. Indian refining companies are largely insulated from these developments as prices of major products are still controlled. One has to add about US$0.5/ bbl to the refining margin towards transport/ handling cost to arrive at landing cost. While earnings growth of Indian companies will not be affected, sentiment particularly of foreign investors has been adversely affected.

In FY97, oil pool deficit grew sharply due to higher crude prices while subsidized product prices have almost halved to less than Rs100bn. In Q1 FY99 despite a nominal adjustment factor, oil pool generated a surplus of Rs30bn. The Government had issued seven-year bonds with 10.5% coupon towards its dues. If the current scenario continues, the government should be able to redeem its bonds by March '99. These redemption's will boost of cash flow PSUs and allow them to invest in expansions/ modernization.

The administered pricing mechanism (APM) which worked on cost plus formula has been dismantled. Prices of 5 key products viz MS, HSD, SKO, ATF and HSD account for 70% of volumes are controlled (but not on cost plus basis). For these 5 regulated products, refineries get adjusted, import parity price is equal to import parity price minus adjustment factor. The adjustment factor is a sort of windfall tax that cannot exceed 5%. In Q1 FY99, the adjustment factor was fixed at a nominal 0.1%.

If a refinery is using local crude oil, then the difference between the import parity price and price paid to the local producer is recovered as a negative surcharge on the 5 controlled products.

The refining companies are free to set the prices of all other products as per market conditions.

Cost of production is calculated on the basis of average international prices in the month preceding the previous. For instance, Aug '98 prices will be based on average cost of imports in Jun '98.

The refinery gate prices for 5 controlled products vary for each refinery depending on the proportion of superior grade (expensive) imported crude oil.

Unlike APM, in the de-regulated environment, realizations depend critically on the product pattern. Effective April 1, 1998, revenue of refineries consists of controlled prices for 5 key products and free market prices for others. This is in contrast to the earlier mechanism where revenues were not relevant for profitability as the companies were assured of fixed return on capital.

BPCL and CRL have superior product pattern with higher proportion of light distillates. But HPCL Vizag, Madras Refinery and some of IOC refineries have relatively inferior product slate.

Under the controlled regime, import duty structure for crude oil and petroleum products was distorted. Import duty on crude oil was higher by 27% compared to the same on products eg 12% on LPG and nil duty on naphtha and SKO. In a free market environment, this would result in disincentive for adding value by way of refining, within the country.

The expert technical group (ETG) recommended rationalization of duty structures in a manner that import duty on crude oil is reduced to 0-5% by the year 2002 and import duty on all products would be around 10-15%.

Rationalization of import duties as suggested by ETG will benefit the refining companies as the protection given to them, currently negative, will improve to around 10%. ETG report forecasts 200-300% jump in refining margins on implementation of decontrol measures. But, in reality, the margin rise could be lower due to several other factors.

As a first step towards rationalization, the Budget FY99 reduced import duty on crude oil from 27% to 22%.

Economics of location will have to be taken into account not only in terms of distance from the market but also sales tax rates.

Sales tax rates vary from state to state.

These levies can not be recovered fully as they could be under APM.