For several decades, central public sector undertakings [CPSUs] in the downstream oil sector viz., Indian Oil Corporation Limited [IOCL], Bharat Petroleum Corporation Limited [BPCL] and Hindustan Petroleum Corporation Limited [HPCL] have enjoyed a virtual monopoly position in refining/production and marketing of petroleum products.
Although, in the last around 2 decades, private sector players such as Reliance Industries Limited [RIL] and Essar Oil limited [EOL] have also emerged on the scene setting up refining capacity on a large-scale, the position of oil PSUs in the domestic market remains unchallenged. This was primarily because of a discriminatory policy and regulatory environment that not only erected entry barriers in marketing but also rendered their operations unviable.
In this backdrop, while one would have expected IOCL/BPCL/HPCL to consistently show good profits, in reality, they have been haemorrhaged by a policy of persistent appeasement of masses by giving massive subsidies [for petty political gains]. Thus, government of the day had controlled prices of all major products viz., petrol [up to June, 2010], diesel [up to October, 2014], LPG [liquefied petroleum gas] and kerosene at artificially low levels un-related to their production cost or import parity price [IPP].
Even though, the government made arrangements for reimbursement of the differential between IPP and selling price [commonly known as under-recoveries], these were ad hoc, arbitrary and lacking transparency. The reimbursements were decided on a quarterly basis and actual payments were made contingent upon available funds [these were invariably short, thanks to inadequate budgetary allocation]. This resulted in substantial interest cost on borrowings needed to fill the gap. Quite often, a portion of under-recovery remained uncovered straight-away eating in to their margins.
A good portion of under-recoveries during last 10 years or so, was covered from discount that oil PSUs received from upstream PSUs viz., ONGC, OIL and GAIL [for instance, during 2013-14, this was over 50% of total under-recoveries of Rs 139,000 crores]. Imagine, if the entire amount were to come by way of subsidy support from government, the problem of delayed payments and under-payments would have been far more serious and could even have turned them sick [however, the collateral damage an otherwise flawed policy of asking ONGC/OIL to share burden has done to these upstream PSUs cannot be wished away. For details pl read:- https://www.uttamgupta.com/oil-gas/ongc-milching-please/]
After taking charge in May, 2014, Modi – government has progressively unshackled oil PSUs. Thus, it decontrolled diesel from November 1, 2014 thereby giving them freedom to fix prices. In case of LPG, even though government continues to ensure that consumers get it at a low price, this is achieved by directly crediting subsidy to their bank account under direct benefit scheme [DBT] [these arrangements covering whole of India are in place since January 1, 2015]. Therefore, for all practical purposes, oil PSUs have been unshackled as they have freedom to sell LPG at full IPP based price. ,
With petrol already decontrolled in June, 2010, the only product now left within purview of control is kerosene. In this case also, government is seriously working on bringing subsidy payments under DBT. Should that be taken to mean that oil PSUs will be able to turn around and move on to a financially sustainable path? With a continuous source of bleeding plugged, undoubtedly, this will bolster the prospects. Indeed, green shoots are already visible if one looks at the 4th quarter of 2014-15 [when we had the full impact of ‘unshackling’ in diesel and LPG].
In the aforementioned quarter, IOCL and BPCL registered impressive Gross refining margins [GRMs] [difference between average selling price of refined products and price of crude] of US$ 8.77 per barrel and US$ 7.85 per barrel respectively. Though lower than the GRMs of private sector refiners US$ 10.1 per barrel and US$ 10.41 per barrel for RIL and EOL respectively, this was a huge improvement over their performance in previous quarters [for IOCL in 2nd and 3rd quarter, GRMs were ‘negative’ US$ 1.95 per barrel and US$ 7.73 per barrel respectively besides a mere US$ 2.25 per barrel in first Qr].
However, to sustain the momentum of recovery, the government will need to take steps to grant them autonomy and freedom to take crucial decisions in regard to sourcing of crude, terms of purchase, marketing and distribution of refined products, investments, entering in to joint ventures etc. In regard to sourcing currently, they have to buy crude only from national oil companies through a tendering process going for an official selling price for one-year contract and cannot negotiate one-on-one. This by itself takes away lot of flexibility which is available to private refiners who can source from anywhere (including spot purchases) and negotiate best terms.
Because of remote control by the ministry, oil PSUs also forego discounts normally offered by sellers. For instance, since late 2014, Saudi Arabia has lowered its official selling price to buyers in Asia and has been selling at discount to Dubai benchmark reference. Other suppliers viz., Kuwait, Qatar, UAE and Iran also follow this strategy.
Oil PSUs also suffer from a major handicap of 90% of their refineries being old and less energy-efficient. They do not have the ability to process a variety of crude including heavy and very low quality crude which can be sourced cheaper than light or good quality crude. Only modern and complex refineries with Nelson Complexity Index [NCI] – a measure of refinery Complexity – of 10 or above have such capability. For IOCL refineries, this is only 9.6 whereas for RIL and EOL this is 12.6 and 11.8 respectively.
The newly commissioned/upcoming refineries of PSUs no doubt meet the aforementioned exacting requirement. For instance, BPCL’s Bina refinery has NCI close to 10 while HPCL’s Bhatinda unit has a complexity of 12. Likewise, IOCL’s upcoming refinery at Paradip will have a Complexity factor of 12.2 making it capable of processing cheaper, high sulphur and heavy crude. But, these companies will have to take urgent steps to revamp and modernize their existing refineries so that they can improve GRMs and stay competitive in a liberalized environment.
For all this to happen, they need to have requisite wherewithal – financial, technological and managerial. Towards this end, the government may consider bringing in a ‘strategic’ partner by modifying the extant approach wherein, the cabinet has approved divestment of only small percentage of its holding [e.g. 10% in IOCL]. Modi should take this next bold step to transform them in to entities capable of matching global giants in regard to scale, efficiency, quality and cost competitiveness.