BOILING RETAIL PETROLEUM PRICES- WHO BENEFITS?

We Indians are having a habit of making things complicated and the pricing of
petroleum products is the one fine standing example of this. We made it so complicated
that even the experts find it difficult to understand. To me it looks as though this is
made so complicated for two reasons. Firstly, to make it difficult to understand and
secondly to make it more debatable. If we go and analyse the problem, standing
outside, then we can see that there is no reason why the oil companies should complain
about the prices of petroleum products. Am I sounding socialistic? Frankly, I am not
one. I am a committed capitalist and as an extension a capitalistic consumer. I demand
value and justification for every rupee spent.

Let’s ask some questions to ourselves! What is this import parity price based on which
the Oil Marketing Companies (OMC) are making this, so called, losses? Simply put, the
import parity price is that price of a product when it is imported to India, considering
the spot global price of the product.

The highest retail price of HSD is in UK at US$7 per Gallon (1 Gallon = 3.875 litters) and
the lowest is in US at US$3 per Gallon. This works out roughly to Rs.81 per litter in UK
and Rs.34 per litter in US. Lets not forget this is based on the international crude prices
at what ever the rates they are purchasing and the conversion cost at their rates.

We all know that India is a low cost heaven for the manufacturers of the world and
taking a cue, we want to develop India as a petroleum refining hub like the success of
the BPO and IT industries. Having one of the lowest manufacturing costs we should be
able to refine the crude at one of the lowest possible costs than our western
counterparts. Are we doing that? The answer is yes, we are doing that. The refining
margin in India is one of the highest in the world at US$6.2 per barrel for IOC to US$12
per barrel for Reliance. The best of Shell’s refineries are operating at a refinery margin
of less than US$2.5.

If you think this is due to the best performance and highest efficiency levels of the
refiners in India, then you are mistaken. This is because, IOC’s employee cost is less
than 0.9% of their turnover and just near 1% of their total cost. The other costs like,
consumables, operation costs are all incurred in India at the Indian cost in Indian
rupees. You might have now got the clue of why they have an impressive refining
margin which puts to shame the biggest and the best of oil companies of the world. On
the whole the refining/conversion cost in the major refineries in India are a paltry 56
paise per litter of petrol.

Now, I think we have a picture on the products cost structure. Put it simply, the prices
that we call as ‘import parity’ for pricing petroleum retail products in India is highly
notional and arbitrary and cannot be considered as the basis. Let’s now see whether the
production cost of these petroleum products in this country has increased? The answer
again is no. This can be simply viewed in the performance report of any OMCs, they
have reported higher growth in their refining margin for the last five years.
Now lets try and ask other questions that the refiners are asking us! The OMCs are
claiming that they are incurring loss on daily basis. What is the loss that they are
incurring? Is it a production loss? Is it a refining margin loss? The answer is a big NO!
This loss that they are reporting is a computed loss on the likely profit they would have
got if they had sold the prices at the ‘import parity’ at the Indian cost of refining! A
simple example is, when they are calculating the conversion cost from US$70 upto the
cost of the product we are adding a 10% of import duty on the import parity of
petroleum products. This again is flawed. 10% on US$70 per barrel on crude oil and
10% on US$82 per barrel on diesel are two different things. Crude we import diesel we
don’t.

In the import parity system, there are interesting facts. As on May 2006, the price of
diesel is $82 per barrel, which is the global price. The crude price is $68. That means, for
conversion of 68 dollars crude outside, there is a conversion cost of 14 dollars. As
explained earlier our refineries conversion costs are minuscule. Even if we give the
advantage of import parity, it will thus be US$82 plus the transportation cost (5%) plus
10 per cent import duty plus insurance (.3%) plus the ocean loss (1%). All this can be
computed and adds upto US$96 per barrel. The cost per litter in Indian Rupees comes to
Rs.27! Surprising that is what surprised me as well. By import parity basis of calculating
the cost has become so complicated that this simple logic will surprise any body. Thus
there is no loss; in fact, there is massive profit to be made. Where else is the extra money
going? To the government kitty to pay off their gigantic bureaucracy to further
complicate the policies.

So it can be well concluded that the basis of fixing prices at import parity was not done
scientifically. The question that arises is why at all create hype about a notional loss
when you are not incurring loss? When the Shells and Exxon’s of the world are making
profit at such a low refining margin selling at similar costs, why should the OMCs given
a blanket protection on pricing. Let’s not forget the early 2004s when the OMCs made a
windfall of profits on higher crude prices. I am not advocating that we should act
against the market forces. All that I am trying to convey is that, higher the crude prices
higher would be the return for OMCs if they were allowed to price their products on
‘import parity’ but at the cost the consumer, who is energy illiterate.

Lesser realisation and loss are two different things and we should accept that. Lower
realisation does not mean that we loose by selling. Loss is real and realisation is
notional in this context. Exxon is selling at lower prices because of their higher
efficiency. We should not neglect the fact that they also import majority of their crude
and are buying from the same global market were our OMCs are purchasing the crude.
We also should not forget that average salary of an engineer working in Exxon or Shell
is 50 times more than the cost of an engineer working in the Indian refineries. We can
well argue that almost all the other operational costs are more than 5 times higher for
Exxon or Shell than for our OMCs. Then where else is our OMCs are loosing.

The answer to this can be found in India itself. When Reliance makes more than US$12
per barrel as refinery margin why should IOC make only US$6 per barrel. Both are
operating at the same conditions and based on same operational cost structures. The
answer to this is the operational efficiency for both these refiners are different. From the
point of crude procurement to the point of bringing the product to the petrol bulk our
OMCs are not as efficient as the private sector refiners in India itself, and forget about
comparing them with the global refiners.

Firstly the OMCs need to learn to hedge their crude cost. There is no well-laid down
system in India or for that matter with our OMCs to hedge the cost of crude. They
always purchase in the spot market or in the less short-term future market without
having a full technical and fundamental analysis of the commodity markets. If the
government allows such a freedom to the refiners this may develop to speculation, but
who cares, world over the Oil market is operating in this way. Secondly, their
operational performance should be matched to the global standards. Thirdly, still the
products are being transported by road in trucks. India with its continental size has one
of lowest product pipeline density. We need not have somebody to teach us
transmission by pipelines is more cost effective than transmission by road or rail. The
pipeline density needs to be improved for transmission of products. We also can
consider transporting through ship for the coastal States.

Through this, so called, import parity prices we are trying to encourage inefficiency
within the system. Once all these concerns are addressed we can truly vouch that India
would be the refining hub of the world, as demonstrated by our colleagues in BPO and
IT by establishing greater efficiency without sacrificing quality.

D.Joel K Pandian
Joel.Pandian@fco.gov.uk