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Updated: January 1, 2012 22:57 IST

Product pricing is the only way to recoup under-recoveries

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R. S. Butola
The Hindu R. S. Butola

With Indian economy poised for major expansion and growth in the coming years, the need for energy has never been felt more than today. In the changing and challenging times, the issue of “Energy Security” has assumed great significance. The public sector Maharatna companies such as Indian Oil Corporation (IOC), find themselves at the crossroads struggling to remain commercially viable on one hand but continuing to serve the ‘common man' by selling LPG, kerosene and diesel at subsidised prices on the other. Sujay Mehdudia caught up with the IOC Chairman R. S. Butola on the future of the company that is ranked in the Fortune 500 list.

Why is petrol price linked with Singapore traded prices when India does not import petrol?

India imports around 85 per cent of its crude requirement and indigenous crude is also procured at prices linked to international benchmarks. Therefore, the pricing of petroleum products in India is based on the principle of import-parity. The benchmark market for the purpose is considered to be Arab-Gulf since this is the natural source of supply for India. Petrol pricing is linked to Singapore market since MS (motor spirit) market in Singapore is a more liquid and well traded market giving the user a credible quote to use.

However, while working out prices in India, the Singapore price of MS is derived at Arab-Gulf by reducing the freight from Singapore to Arab-Gulf and this derived price ex-Arab-Gulf is then used as the basis for price calculation.

Is not the concept of ‘under-recovery' artificial because there is zero import of petrol and diesel? What is the point in comparing landed cost of petrol, including duties, freight and insurance with retail prices and then complain of under-recovery?

It can't be said that there is nil import of petrol and diesel. Small quantities are being imported. There is no artificial under-recovery. It is a real loss of revenue. Under-recovery is the difference between the procurement price of products and their selling prices. While the procurement prices, which are import-parity based, change in line with international prices, the selling prices of sensitive products are controlled by the government. The difference between the two gives rise to under-recoveries. As I said earlier, India imports 85 per cent of crude on which all these costs (duties, freight and insurance) are incurred. There is no way of recouping these except through product prices. Hence the principle of import-parity price of petroleum products is used.

Will IOC accept cost-linked pricing structure for fuels, specifically petrol and diesel?

Individual product-wise costs are not identifiable separately because oil refining is a process industry, where crude oil is processed in several processing units and require further blending of intermediate product streams from various units for making finished petroleum products. This process makes it difficult to apportion the total cost of individual refined products.

The only option is product-wise allocation of total refining costs on some assumed basis, thus making the costs notional. Therefore, cost based pricing is not adopted for petroleum products.

Why do the three oil marketing companies (OMCs) follow a uniform pricing policy? Is this not anti-competitive practice? Why is IOC averse to following its own pricing policy?

Except for sensitive products, OMCs, including IOC, follow independent pricing policies.

Is the runaway growth in diesel consumption related to its relatively lower price compared to petrol or is the demand growth genuine?

Demand growth of high speed diesel (HSD) is due mainly to the controlled price regime for the product making it artificially cheaper compared with other fuels. While the number of diesel vehicles is increasing due to price differential between petrol and HSD, leading to higher HSD consumption, there are other reasons for growth in diesel consumption.

At present, diesel price is below furnace oil and also has a higher calorific value compared with furnace oil. Furnace oil is largely an industrial fuel. It is a key ingredient for generating electricity and heat in a number of production units. Since the calorific value of diesel is higher than furnace oil and it is a cleaner fuel, it makes economic sense for consumers to switch over to diesel from furnace oil whenever the price is favourable. This is now a key driver of HSD growth.

Your borrowings are around Rs.80,000 crore. Do you feel the need to borrow more in the coming year? If so, how will it affect your balance sheet?

It is true that IOC's borrowings are above Rs.80,000 crore and to be precise around Rs.80,900 crore. The IOC board recently met and increased the borrowing limit to Rs.1.10-lakh crore. The borrowings have considerably been increased from Rs.52,000 crore at the beginning of the financial year mainly due to continuous under-recoveries in marketing diesel, LPG and kerosene. The compensation of Rs.16,437 crore sanctioned by the government towards under-recoveries has not been received so far.

The price of crude oil has remained high for quite sometime. Besides, the rupee has depreciated significantly against the dollar. This has led to increase in the working capital, thus requiring funds to be borrowed. There is an interest of Rs.2,000-2,500 crore to be serviced which is a severe burden on the balance sheet.

How much have the financial problems affected your capital expenditure plans and commissioning of new projects?

We have not let the current situation impact our capex. IOC has not allowed any of its on-going projects to suffer for want of funds. However, in case there is a perpetual constraint in internal generation of resources, it will lead to difficulties in planning of new projects.

What is the update on the Paradip refinery? Is the project within committed time and cost estimates?

IOC's latest refinery at Paradip, once completed, will be the most modern with state-of-the-art technologies from across the world. The refinery is designed to process 15 million tonnes per annum of crude with an overall Nelson complexity factor of 11.3 which makes it capable of processing cheaper, higher sulphur and heavy crude. (Nelson Complexity Index is a measure of secondary conversion capacity in comparison to the primary distillation capacity of any refinery. It is an indicator of not only the investment intensity or cost index of the refinery but also the value addition potential of a refinery.)

As of November 2011, the project had achieved 70 per cent overall physical progress, 98 per cent engineering progress and 45 per cent construction progress. Out of the project cost of Rs.29,777 crore, commitment of Rs.28,150 crore has been made and an expenditure of Rs.11,436 crore incurred.

"....indigenous crude is also procured at prices linked to international benchmarks. Therefore, the pricing of petroleum products in India is based on the principle of import-parity. " - May I ask why indigenous crude is procured on import-parity basis? Why is that cost benefit not passed on to the consumers?

from:  Chetan Tirthani
Posted on: Jan 17, 2012 at 18:13 IST

The concept of following government dictate on product pricing is unacceptable and also government directive as "Unconstitutional" and violative of Article 19 fundamental rights guaranteed by the Constitution of India. All OMC are public listed companies in which the public at large is substantially interested. The management of these OMC are mandatorily required to follow the interest of the shareholders, especially minority shareholders. Under Article 19 (Fundamental Rights) of the constitution of India, all citizens of India (including body corporate) are granted absolute rights to conduct their business freely and without any restrictions. (Freedom to trade). As such, these companies can spurn the government directive and independently decide the product pricing based on its cost structure. However, the management of these is tame and subservient to government interest. There is constitutional obligation on government to let these companies follow independent price policy.

from:  Kalidas
Posted on: Jan 2, 2012 at 13:49 IST

Governments and OMCs should not raise petrol prices in any case 1. Petrol prices are highest 2. Petrol is not fuel of rich 3. Petrol cannot finish or reduce oil sector losses as it is only 10 % of petro products sales 4l increase price differences and hence corruption and use of more subsidized petro products.5. It will give a bad name to policy makers and India.6. Motor fuels are lifeline of nation 7 .Motor fuel price hikes are inflationary.8. It is not the right medicine which is finishing subsidy on noninflationary and easily replaceable LPG and kerosene subsidy and similar reduction in taxes on inflationary and irreplaceable petrol and diesel. 8. It will kill automobile industry 9. It will kill the spirit of petrol users. Use of other cheaper indigenous energy sources use in place of petro products use is also urgent request of our mother India.

from:  Alok
Posted on: Jan 2, 2012 at 11:01 IST

While I agree that product pricing is the only way to compensate for under-recoveries it is naive to believe that the business started only yesterday.If all the oil majors have developed heavy profits leading to billions of dollars in their cash reserves it would seem that they have grown used to such a thing that they squirm when that situation cannot continue.No doubt today the cost of prospecting is high and the oil may well run out in time but technology has not stood still and other forms like fuel, hydrogen, solar, wind energy, fuel cell,and of course a promise of Natural gas (LNG) supplies for 250 years by the industry.They can spread their reserves and invest judiciously and take it from a host of energy forms and not concentrate on taking it from oil products continously.(if the gullible or hapless people allow).

from:  Prof.Paul.V.John
Posted on: Jan 2, 2012 at 09:21 IST
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