oil sector - pricing of oil in india

8/3/2019 Oil Sector - Pricing of Oil in India

1/92

Oil Sector :Pricing of oil in

India

1


2/92

INDEX

Sr. No Topic Page No

1

2

3

4

5

INTRODUCTION

1.1 Research Objective

1.2 Research Methodology

1.3 Review of Literature

INDIAN CRUDE OIL MARKET

2.1 Historical Background

2.2 Production of crude oil in India

2.3 Indian Energy Industry Structure

OIL PRICING POLICY IN INDIA

3.1 Facts and Figures3.2 Latest development

FACTORS INFLUENCING OIL PRICES IN

INDIA

ROLE OF GOVERNMENT IN OIL SECTOR

5.1 Policy Initiatives

5.2 Opportunities

1 4

5 12

13 - 17

18 20

21 24

2


3/92

6

7

8

9

10

IMPACT OF UNION BUDGET

6.1 Background

6.2 Budget Proposals6.3 Budget Impact on Industries

6.4 Budget impact on companies

CRUDE OIL FUTURES

7.1 Introduction

7.2 Benefits of MCX crude futures

GOVERNMENT TAXES ON FUEL

8.1 Subsidy allowed on fuel prices

8.2 Central Excise and custom tariff

8.3 Dealers commission on Petrol and Diesel

8.4 Distributor Commission on LPG

IMPACT OF INCREASE IN OIL PRICES ON

GROWTH AND INFLATION LEVELS IN

INDIA

REAL COST OF PETROL IN INDIA

25 29

30 34

35 42

43 46

47 50

3


4/92

11

12

13

14

15

16

CHANGE IN PRICE OF CRUDE OIL

PRICE DISCOVERY

Introduction

Indian Condition

The Issue Of Asian Risk Premium : Dubai

Crude Being An Ineffective Marker

Solutions to the problem of Asian Risk

Premium

Need For Supply Chain Efficiencies

Case of other Markets

o a)TOCOM

o b)SIMEX

RECOMMENDATION

CONCLUSION

APPENDIX

BIBLIOGRAPHY

51

52 63

64 70

71 72

73 75

76 - 78

4


5/92

LIST OF FIGURES


1

2

3

4

5

6

PLAYERS IN INDIAN OIL SECTOR

PROCESSING AND DISTRIBUTION OF OIL

AND ITS FINISH PRODUCTS

PROJECTION OF GDP IN 2050

EVALUATION OF PETROL AND DIESEL

PRICES

CHANGE IN CRUDE OIL PRICES AND ITS

FINISHED PRODUCTS

CONSUMPTION OF DIESEL BY DIFFERENT

USERS

10

11

20

49

51

67

5


6/92

LIST OF TABLES


1

2

3

4

5

6

7

8

9

10

11

CHANGE IN DUTY STRUCTURE

BUDGET IMPACT ON COMPANIES

INTERNATIONAL OIL PRICE VARIATION

MAXIMUM PRICE VARIATION

SUBSIDARY ON PDS KEROSENE AND

DOMESTIC LPG UNDR SUBSIDARY

SCHEME 2002

SUBSIDARY FOR FAR FLUNG AREAS

UNDER FREIGHT UNDER SUBIDIARY

SCHEME 2002

CENTRAL EXCIZE AND CUSTOM TARIFF

DEALERS COMMISSION ON PETROL AND

DIESEL

DISTRIBUTORS COMMISSION ON LPG

IMPACT OF OIL PRICES

FACTORS FOR PRIC DISCOVERY ON MCX /

NCDEX

27

29

34

34

36

37

38 40

41

42

44

57

6


7/92

12

13

WORLD OIL DEMAND 2010

AVERAGE ANNUAL USE OF PETROL PER

VEHICLE

59

64 - 65

7


8/92

ABSTRACT

Oil is vital to the world economy and the world consumption of oil, driven bycountries such as India and China, is set to rise significantly.

Since the horse and carriage gave way to the car as the main method of

transportation oil has been vitally important to the world economy. Its importance has

risen to the extent that in a world suddenly without oil, all the minor and major

distribution systems that allow economic transactions on a more than local basis would

fail and the world economy would collapse.

Many people underestimate the significance of oil and natural gas in modern

civilisation, and mainly associate oil with the petrol or diesel that they put in their cars.

However, the value of oil to our world goes far beyond our personal transportation

choices as many of the everyday items we use are either made from oil or are dependent

upon oil for their production.

The fruit and vegetables on supermarket shelves are highly dependent upon oil -

from the fuel oil used to harvest and then transport these goods around the world, to the

petrochemical feedstock used to manufacture the pesticides and herbicides that maintain

high yields. Even fertiliser is dependent upon large amounts of hydrocarbons for its

manufacture. The whole of our modern food chain is completely dependent on oil,

meaning that the future of agricultural production is vulnerable to depletion of this non-

renewable resource.

Many consumer goods are made of plastic, a material utilising petrochemicals in its

manufacture. Many common medical and pharmaceutical products also have oil as a

8


9/92

basic constituent. The aspirin, originally processed from the bark of the willow tree, is

now another of these many oil derivatives.

Oil has proven to be such a flexible resource that it now underpins many of the

items we take for granted in the modern world, and any interuption of its supply would be

very serious. In light of the dual challenge of Peak Oil and anthropogenic climate change

it is critical that we develop targeted interventions to ensure that we do not waste

important resources

When the oil price increases, it not only directly raises the cost of fuel/gas for

consumers, but it also raises the costs of all other goods that are transported. These priceincreases will be passed on to the consumer, giving rise to inflation.

With prices rising, workers (and/or unions) will pressure employers for higher

wages to compensate for the increased cost of living. If there is a risk of price increases

translating into a spiral of rising producer costs and wages then central banks is likely to

intervene by tightening monetary policy by for example raising interest rates. The

higher interest rates will then act as a signal to market participants that monetary

authorities will not tolerate higher inflation. (Higher interest rates will lower disposable

income and suppress demand therefore making it difficult for firms to pass on price

increases and/or agree to excessive wage demands).

To come back to your question on the impact on food items, higher energy prices

affect production costs (directly through fuel and fertilizers), as well as due to the higher

the cost of moving food from the farm gate to the market. Obviously, the effect will be

less for commodities with a high value and low weight and vice versa. Estimates suggest

that a 10% increase in energy prices is associated with a 2 to 3% increase in the prices of

9


10/92

grains and vegetable oils and also that over the longer term, high energy prices tend to

affect food prices through the biofuel channel

10


11/92

LIST OF ABBREVIATIONS

OPEC : Organization Of Petroleum Exporting Countries

E&P : Exploration and Production

R&M : Refining and marketing

ONGC : Oil and Natural Gas Corporation Limited

IOC : Indian Oil Corporation Limited

HPCL : Hindustan Petroleum Corporation Limited

BPCL : Bharat Petroleum Corporation Limited

CPCL : Chennai Petroleum Corporation Limited

BRPL : Bongaigaon Refinery & Petrochemicals Ltd.

NRL : Numaligarh Refinery Limited

MRPL : Mangalore Refinery and Petrochemicals Limited

IGL : Indraprastha Gas Limited :.

LNG : Liquefied natural gas

11
http://www.iglonline.net/http://www.iglonline.net/http://www.iglonline.net/http://www.iglonline.net/


12/92

L&T : Larsen and Toubro

IBP : Indo-Burma Petroleum Company

KRL : Kochi Refineries Ltd

RPL : Reliance Petroleum Limited

RIL : Reliance Industries Limited

APM : Administered Pricing Mechanism

GDP : Gross Domestic Product

WPI : Wholesale Price Index

NPL : New Exploration Licensing Policy

LPG : Liquidified Petroleum Gas

FDI : Foreign Direct Investment

LNG : Liquefied natural gas

US : United States

OMCs : Oil marketing companies

12


13/92

MS : Motor Spirit

HSD : High Speed Diesel

LDO : Light Diesel Oil

MoPNG : Ministry of Petroleum and Natural Gas

PSEs : Public Sector Enterprises

MRP : Maximum Retail Price

CVD : Counter Vailing Duty

RBI : Reserve Bank of India

MCX : Multi Commodity Exchange of India

PDS : Public Distribution System

CVD : Central VAT Duty

VAT : Value-added tax

CDU : Crude Distillation Unit

VDU : Vacuum Distillation Unit

13


14/92

FCC : Fluid Catalytic Cracking Unit

NCDEX : National Commodity and Derivatives Exchange of India

PSU : Public Sector Undertaking

ATF : Airline Turbine Fuel

IEEJ :Institute of Electrical Engineers of JapanTOCOM : Tokyo Commodity Exchange

SIMEX : Singapore International Monetary Exchange

KM : Kilometer

MVP : Multi purpose vehicle

Bbl : Barrel / liter

MSP : Minimum Support Price

LCVs : Light Commercial Vehicles

SUVs : Sports Utility Vehicles

14


15/92

IEA : International Energy Agency

NYMEX : New York Mercantile Exchange

PPAC : Petroleum Planning and Analysis Cell

MOSPI : Ministry of Statistics and Programme Implementation

CHAPTER 1

INTRODUCTION

15


16/92

Oil is the single most important commodity that holds the position of a key factor

in each and every economy of the world. The worlds richest nations are at their current

positions just because of the oil factor. The importance of oil has reached such a level at

which there is no country in the world, which doesnt need oil and its by-products, and if

somehow it doesnt have much reserves of oil to meet their domestic demand, these

nations are ready to import the product at any cost. Many nations have a huge share of

their earnings constituted by oil exports only.

Every industry requires oil to function properly either directly or indirectly as both

crude oil and its by-products serve as their inputs. Crude oil alone bears 60% share to

meet the global energy needs in the current scenario. The reason for this high share in the

primary energy consumption in the world is due to the advantages that oil has over the

other constituents of primary energy such as diverse application, comparatively lesser

harm to the environment, easy handling, lower capital costs and above all higher

efficiency.

Oil units

1 Tonne = 7.33 Barrel = 1.165 Cubic Metres (kilolitres)

1 Barrel = 0.136 Tonnes = 0.159 Cubic Metres (Kilolitres)

1 Cubic Metre = 0.858 Tonnes = 6.289 Barrels

1 Million Tonne = 1.111 Billion Cubic Metres Natural Gas

= 39.2 Billion Cubic Feet Natural Gas

= 0.805 Million Tonnes LNG

1.1 RESEARCH OBJECTIVE

16


17/92

The report gives the brief background of the pricing of oil and its finished products

in India and proceeds to highlight the short comings of the existing setup and players in

the oil market. The report also tells us that how Government of India, oil companies and

other intermediaries in oil sector decide the oil price in India.

The price discovery which takes place in crude oil futures tells how it is benefited

to the participants and the exchange itself. A comparative study is done between the

countrys commodity exchange with some of the premiere exchanges of the globe and

the researcher has come up with a solution.

Recommendations are given with respect to pricing of petrol and diesel which will

help not only the users but also for India in order to reduce the inflation which is causing

due to increase of crude oil prices globally.

1.2 RESEARCH METHODOLOGY

A ) PRIMARY DATA

The primary data is generate by interviewing the owner of Ravi Auto Services,

Worli and Mr. G. Chandrashekhar, Associate Editor of "The Hindu Business Line"

newspaper.

B) SECONDARY DATA

The sources from which secondary data was collected are:

Books, Journals, Newspapers and Magazines, Internet.

1.3 REVIEW OF LITERATURE

17


18/92

The International Energy Agency (IEA) in their report PETROLEUM

PRICES, TAXATION AND SUBSIDIES IN INDIA (2009) have studied on

downstream petroleum product pricing in India. The study examines the current pricing

mechanism and taxation and subsidy regime on four key petroleum products (petroleum,

diesel, domestic kerosene and domestic LPG). In the study, the implications of current

arrangements in each of these markets for central and state government revenues and

expenditures, for the countrys macro-economic positioning as well for upstream and

downstream sector development are to be examined in detail.

International Energy Agency: Focus on Asia Pacific report Petroleum product

pricing in India says that there is frequently a black hole of subsidies. Economists and

oil companies complain about the impacts those subsidies have on public finances,

financial performance of oil companies and demand-side management. However, on

closer analysis, the issue of petroleum product pricing in India is more complex than the

one-way flow of subsidies reported in the press.

Stein Tonnesson and Ashild Kolass ofInternational Peace Research Institute,

Oslo (PRIO) 2006 analyzes the strategic implications of India and Chinas growing

consumption of energy, notably of imported oil, and the two countries quest for energy

security. India currently imports roughly 70% and China around 40% of its oil. As the

energy needs of both countries continue to grow, their oil imports are set to increase

substantially. Due to the size of their populations and their rapid economic growth, India

and China face a formidable challenge in their pursuit of energy security. How the two

governments seek to meet this challenge is vital to the future political stability of Asia as

a whole

18


19/92

Government Of India, New Delhi Report on A Viable and Sustainable

System of Pricing of Petroleum Products : February 2010 - A viable and sustainable

pricing system for petroleum products is a key requirement ofstable, long-term growth of

the economy. Similarly, a financially strong and globally competitive oil industry

provides an enduring platform to strengthen energy security ofthe country. It is therefore

important that oil companies should have the freedom to setprices based on competitive

market conditions. The government needs to extend subsidyto the targeted consumers in

such a manner which does not impinge on the freedom of oilcompanies to set prices in

the market place.

CHAPTER 2

19


20/92

INDIAN CRUDE OIL MARKET

2.1 Introduction

India is one of the non - OPEC countries much dependent on its imports to fulfill

the domestic consumption demand as it has a much lower level of production. India is a

developing country and the requirement for the oil as a primary energy constituent from

the industries in the country is at its peak. The country has much depended on coal to

satisfy its energy needs in the earlier times but the use of crude oil and gas is taking over

the dominance of coal with the change in time. Oil and gas contribute to around 45% of

the countrys total energy consumption.

20


21/92

India has around 5.4 billion barrels of oil reserves with it and the domestic

production has increased in the recent past to reach the 0.8 million barrels per day mark.

Mumbai high is the largest oil - producing oilfield in India with a production of 2.6 lakh

barrels per day. The refining capacity of crude oil in India is estimated at around 2.1

million barrels per day. Regarding the consumption pattern of oil in India, it is the 6th

largest consumer country in the world having a consumption of 2.2 million barrels per

day. This leaves the country with a huge deficit in the demand - supply scenario and thus

70% of the consumption is met through imports.

India generally imports Oman - Dubai sour grade crude, Brent dated sweet crude

and Bonny light crude. The country imports over 1.5 million barrels per day that place it

at the 9th position among the largest importers of the world. Though the Indian

production has increased in the recent times, the imports were raised by 5% making due

to the raised Indian demand of around 4.2%. The countries from which India imports

crude oil are:

Venezuela

Nigeria

Sudan

Iran

Kuwait

The Indian oil-refining sector has been regulated by the government historically

and is still dominated. A new private sector has emerged after the loosening of controlby the government. The major units pertaining to the oil sector in India are:

Indian Oil Corporation (Public sector)

Oil and Natural Gas Corporation (Public sector)

21


22/92

Reliance India Ltd (Private sector)

Essar Oil Refinery (Private sector)

Bharat Petroleum Corporation Ltd (Public sector)

Hindustan Petroleum Corporation Ltd (Public sector)

Mangalore Refineries and Petrochemicals Ltd (Public sector)

2.2 Historical Background

The history of the oil sector in India dates back to the late 19th century, when oil

was first struck at Digboi in Assam in 1889. In the subsequent period, till the 1960s, oil

exploration and production activities were largely confined to the North-Eastern region.

The daily crude oil production then averaged 5,000 barrels per day. The later discovery

of the Cambay onshore basin (in 1958) and the Bombay offshore basin (in 1974)

enhanced the production to the current level of 0.7 mn. barrels per day (mbd). In the

downstream sector, the first refinery was set up at Digboi in 1901.

However, new capacities were added only in the late 1950s - early 1960s by

international majors such as Shell, Caltex, and Esso. Refineries were also set up by

the Government in the 1960s. Although the exploration and production activities were

dominantly under Government control, the nationalisation of both the upstream and

downstream sectors was initiated after the Oil Shock of 1970s and completed on

October 14, 1981. As a result, the international oil companies withdrew from India.

2.3 Production of crude oil in India

22


23/92


24/92

Upper Assam (Assam)

Cambay (Gujarat)

Krishna - Godavari basin (Andhara Pradesh)

Cauvery basin (Tamil Nadu)

Nagaland Arunachal Pradesh

The largest crude oil producing oilfield is the Mumbai high field that produces

around 260000 barrels per day. Among these production centers, major share of

production i.e. 2/3rd share is bagged by the offshore reserves as compared to onshore

reserves. The refining capacity of crude oil in India is over 2.1 million barrels per day.

The refining sector in India is held by both public and private sector, public sector being

the dominating one.

2.4 Indian Energy Industry Structure

The Indian oil sector has historically been a regulated one dominated by

Government undertakings. However, with the Government loosening its control, new

private sector players are now gaining presence. Unlike the international oil majors

which have integrated operations along the energy value chain, the Indian oil sector

has companies operating in three distinct sub-segments: Oil & Gas Exploration and

Production (E&P), Oil Refining and marketing of refined products (R&M) and,

Distribution of Natural Gas.

Figure no. 1 : Players in Indian Oil Sector

24


25/92

ONGC is the major player in the Indian E&P sector. Other players include Oil

India Ltd., Reliance Industries, Indian Oil Corporation, Gas Authority of India Ltd.,

British Gas, Essar Oil, Videocon, Cairn Energy, Hindustan Oil.

Figure no. 2 : Processing and Distribution of oil and its finished

products

25


26/92

Exploration Company: Niko Resources, Gazprom, Energy Equity, Geoenpro

Petrol Ltd., Geopetrol International, Enpro India Ltd., Hardy Oil, Tata Petrodyne,

Gujarat State Petroleum Corporation, Selan Exploration Technologies Ltd., L&T, Joshi

26


27/92

Tech., Interlink Petroleum, Mosbacher, Tullow Oil, Phoenix, Okland International,

Premier Oil and Geo Global Resources.

Government Controlled Companies: ONGC, OIL, IOC, HPCL , BPCL and

GAIL. CPCL, BRPL and IBP have now become subsidiaries of IOC. KRL and NRL are

now subsidiaries of BPCL.

Joint Sector Companies: MRPL used to be a joint sector company with equal

stake of HPCL and Aditya Birla Group.

Private Sector Companies: Reliance Petroleum Ltd. (RPL) - which has now

been merged with parent Reliance Industries Ltd. (RIL), Gujarat Gas.

CHAPTER 3

OIL PRICING POLICY IN INDIA

27


28/92

Crude influences the economy in many ways. Not only it directly affect the

manufacturing industry but also affects ones personal disposable income in real terms.

India is almost a free market economy now, unlike even a decade back. The Indian oil

industry has been deregulated, the oil prices decontrolled. The poor common man

wonders whats in store for him next.

3.1 Facts and Figures.

28


29/92

First, with about 80% import dependence, we cannot afford to divorce domestic

retail prices from international oil prices. Buying crude at high prices and selling products

processed from that very crude at artificially low retail prices is just not sustainable.

Prices have to reflect costs.

Second, price volatility in international oil markets is today a norm, rather than the

exception. There are just too many factors influencing oil prices Organisation of

Petroleum Exporting Countries (OPEC) decisions; conflicts in the Middle East; US crude

stock levels; the harshness of the European winters; and so on.

Third, the erstwhile - administered pricing mechanism (APM) protected the Indian

consumer from the ups and downs in the global markets through the oil pool. The pool

absorbed the volatility and kept retail prices stagnant. In April 2002, however, the APM

for the oil industry was dismantled.

The oil pool is now defunct. Save the government directive to oil companies to

hold price lines for some time, the common man would have already been fully exposed

to the vagaries of the global oil markets. Lastly, it must be borne in mind that the said

directive, is at best, temporary.

Distilling the facts, it follows, that eventually domestic retail prices will start

reflecting international oil prices. In fact it does reflect the same. The best way to analyse

the system is to consider it in two distinct segments refining and marketing, even while

considering prices offered by one single company. The refining division would procure

crude from international markets; process it; and transfer products to the marketing

division at the refinery gate. Margins in the refining industry are embedded in the

inherent crude and product price differentials in international oil markets. The transfer

29


30/92

price for products at the refinery gate thus reflects international product prices, what is

typically referred to as the import parity price of that product. Deregulation to this effect,

i.e., affecting refinery purchases and receivables at import parity prices, actually took

place way back in April 1998 itself.

This refinery gate price, essentially, becomes the base price for the final consumer.

Added to this are distribution costs; excise duties; sales tax and other local levies; and

finally the marketing margin. The only variable element in this entire list of mark ups is

the marketing margin, and hence, it becomes one of the most crucial elements in price

fixation in a deregulated environment. Under the APM, marketing margins were decided

by the government in relation to the net worth of the companies, and reimbursed through

the oil pool. An important point to note is that the margin was fixed and was not adjusted

from a month-to-month basis as done for the refinery gate product prices. (Actually there

are daily variations in prices in international oil markets, but in India these were averaged

out over a period for simplification and administrative).

It is this system which changes with the now announced full deregulation of the

industry. In deregulated environment, market prices would be driven by competition. In

mature markets in the West for instance, pump prices of one company differ from that of

another. Oil companies for market share through aggressive stands on marketing

margins. In addition, there are weekly/fortnightly price revisions. In times of high oil

prices, oil companies moderate the impact of high international prices by taking a squeeze

on their margins.

The long and short of it the Indian consumer should reconcile himself to frequent

price adjustments (either way, upwards and downwards). As international oil markets

become tight, global prices would rise, and so would domestic retail prices. The common

30


31/92

man may be on the short-end of it on account of market sentiments alone. The oil

companies would play their role in moderating the price fluctuations to some degree by

contracting/expanding their marketing margins. Under the APM, they enjoyed guaranteed

returns. Now, the common man on the street is their bread maker and they will go all out

to appease him. Of course, the bottom line of the game is still profits.

3.2 Latest development:

Even as global petro-product prices continue to be northward bound, retail

consumers back home will remain insulated from the volatility in globalprices.

The government has formulated a price band for auto fuels petrol and

diesel within which oil marketing companies will be free to revise prices

automatically.

Though the mechanism talks about a band within which prices will be revised

every fortnight, retail prices of petrol and diesel are unlikely to see much of a

change in the coming days. Since global prices have remained firm, oil

companies are currently selling petrol and diesel close to the top end of the

band.

The moving price band will be based on the average of the global prices in

the immediate past three months and the past one year. Oil companies will

have the limited freedom to revise prices (both upwards and downwards) up

to 10% of this mean price.

31


32/92

CHAPTER 4

FACTOR INFLUENCING CRUDE OIL PRICE IN INDIA

32


33/92

The petroleum sector has a major influence on the inflationary trend in a country

like India. This is because in India (like in many other developing countries), the total oil

consumption in relation to GDP is relatively high as compared with many developed

countries in North America and Western Europe.

A high level of oil consumption in relation to output implies high oil intensity.

China, South Korea and Mexico are the other most oil intensive nations with oil

consumption to GDP ratios of 0.26, 0.2 and 0.31 respectively, during 1998. Japan and

four major European countries (France, Germany, the UK and Italy) are the least oil

intensive. The last decade and a half has shown a marginal change in oil intensity across

nations.

In the case of India, because of a high level of oil intensity (in relation to GDP), the

energy sector (Fuel, Power, Light & Lubricants) has a significantly higher share of

14.23% in the Wholesale Price Index (WPI), which is a measure of inflation in the

country. This figure implies that for every 10% rise in the prices of products in the energy

sector, the inflation (as measured by WPI) would go up by 1.4 percentage points.

The office of the Economic Adviser to the Government of India, Ministry of

Commerce & Industry, has replaced the old series of WPI (Base: 1981-82=100) by a

new series with a base 1993 94 = 100 for the Wholesale Price Index with effect

from the week ending 1st April, 2000. As per this new base, the share of Fuel, Power,

Light & Lubricants is 14.23% in WPI as compared to 10.66% earlier. This is due to

the structural change in the economy since 1981-82.

Intensity of traffic is steadily increasing in India. Demand from this section of the

is a major determinant of oil price. This sector consumes a very high amount of oil,

33


34/92

considering all the major modes of transportation. It in turn, further demonstrates the

importance of the petroleum sector in the Indian economy. In the case of the railways,

petroleum accounts for around 7% of the total revenue earning traffic. The POL traffic

using the railways more than doubled to 36.2 million metric tonnes during 2000 - 2001

from 14.95 million metric tonnes in 1980 - 81. Similarly, petroleum accounts for around

38% of the total port traffic in India, and in volume terms, the traffic more than trebled to

107 million metric tones during 2000 - 01 from 34 million metric tonnes in 1980-81.

Since India is a growing economy with GDP expected to grow at 8 10% per

annum, demand from the manufacturing sector is expected to grow manifolds. In fact

development economist predict that by 2050 India will be the third largest economy in the

world .

Figure no. 3 : Projection of GDP in 2050

34


35/92

CHAPTER 5

ROLE OF GOVERNMENT IN OIL SECTOR

35


36/92

India is one of the top 10 oil - consuming countries in the world. Oil and gas

represent over 40 per cent of the total energy consumption in India. The consumption of

petroleum products in the country is on the rise and demand already far exceeds domestic

supply. Therefore, the country has to depend largely on imports.

The countrys existing annual crude oil production is peaked at about 32 million

tonnes as against the demand of about 110 million tonnes. With inadequate crude

production, the country is heavily dependent on imports. Crude is the single largest item

on Indias import list. Estimates show that the demand is likely to grow at a faster pace

over the next decade if India is to maintain the GDP growth target of 8 per cent. This

implies larger imports unless new domestic oil reserves are found. With this in view, the

government announced the New Exploration Licensing Policy (NELP) in 2000. With a

view to ensure long-term energy security, the government is also building oil and gas

equity abroad.

5.1 Policy Initiatives

The deregulation of the petroleum sector has been completed on schedule (March

2002) with the government completely dismantling the administered pricing

mechanism for all petroleum products except kerosene and LPG. As a result, the

petroleum product prices will be market determined and the marketing companies

will be free to set prices.

The government offers both off - shore and on - shore exploration blocks under the

NELP for Indian and foreign private participants. Several exploration blocks have

already been given out in the first two rounds of NELP. Currently the third round

36


37/92

NELP III of bidding out blocks is on. A total of twenty-seven blocks, covering

eleven on land, seven shallow-water offshore and nine deep-water offshore have

been offered by the government for exploration. So far, contracts with private

investors have been signed for 47 blocks in the two rounds of licensing. The recent

Reliance discovery of major natural gas reserve has given a major impetus for new

explorations.

The government allows 100 per cent foreign equity in private refining ventures.

However, FDI in refineries promoted by public sector companies is restricted to 26

per cent. Foreign equity participation in petroleum product marketing has been

capped at 74 per cent. Foreign equity investment in oil and gas pipeline projects is

currently restricted to 51 per cent.

The government has allowed private companies to market petroleum products in

the country provided that the private company either produces 3 million tonnes or

more per annum of crude or has invested over US$ 400 million in the countrys oil

and gas related infrastructure sector.

In order to improve the viability of stand-alone refineries, the government has

linked them to the major public sector oil companies.

5.2 Opportunities

37


38/92

Entire gamut of exploration & production, refining, transportation & distribution

and retail marketing activities present opportunities for FDI:

Production sharing contracts for oil and gas exploration under NELP.

Supply of crude oil.

Supply of gas.

LNG import and transportation.

Setting up refineries.

Marketing petroleum products including LPG.

Setting up of petroleum infrastructure like storage facilities, pipelines, etc.

Retail marketing of transportation fuels.

As part of its divestment strategy, the government is likely to privatise some of the

major public sector oil companies in the near future. At least a change the equity structure

is very much in the offering. This provides a good investment opportunity for

entrepreneurs looking at investing in this sector, or entering the petroleum retail market.

The country has traditionally operated under an Administered Pricing Mechanism

for petroleum products. This system was based on the retention price concept under

which the oil refineries, oil marketing companies and the pipelines are compensated for

operating costs and are assured a return of 12% post-tax on net worth. Under this concept,

a fixed level of profitability for the oil companies is ensured subject to their

achieving their specified capacity utilisation. Upstream companies, namely ONGC, OIL

and GAIL, are also under retention price concept and are assured fixed return.

38


39/92

The administered pricing policy of petroleum products ensured that products used

by the vulnerable sections of the society, like kerosene, or products used as feed stocks

for production of fertilizer, like naphtha, may be sold at subsidized prices.

Gradually, the Government of India moved away from the administered pricing

regime to market determined, tariff-based pricing. Free imports are permitted for almost

all petroleum products except petrol and diesel. Free marketing of imported kerosene,

LPG and lubricants by private parties is permitted. It is contemplated that in a phased

manner, all administered price products will be taken out of the administered pricing

regime and the system will be replaced by a progressive tariff regime in order to provide a

level playing field for new investments in a free and competitive market.

CHAPTER 6

IMPACT OF UNION BUDGET 2004-05 ON OIL SECTOR

39


40/92

6.1 Background

Crude oil prices remained volatile during FY04 and 1st quarter of FY05 mainly

due to geopolitical tensions such as Iraq war, strike by workers in Venezuela and

Nigeria, lower level of inventory held by US and higher demand from China.

Although APM was dismantled w.e.f April 1, 2002 oil companies have rarely

priced end products on commercial basis. Increasing price of crude during FY04

had adverse impact on oil companies in India as end fuel prices were not reset toreflect the increase in prices of crude. On June 15, 2004, the retail price of petrol

was hiked by Rs.2/litre, diesel by Rs.1/ litre and LPG by Rs.20/cylinder. Also,

excise duty on petrol was reduced by 4% to 26% and diesel by 3% to 11%.

Post APM, two Regulatory Commissions; one for upstream sector and one for

downstream sector were proposed to be set up. This was to ensure availability of

products in far flung places as well as to avoid price shocks and monopolistic

behavior of oil companies. These Commissions have not yet been set-up.

Petroleum Regulatory Board Bill, 2002 which incorporates the framework for

regulatory bodies, is pending in Lok Sabha.

In September 2003, GAIL and ONGC were asked to share subsidy burden on

account of sale of kerosene and LPG by public sector oil marketing companies

(OMCs) to retail consumers. In a three-way split, the Government decided to

transfer one-third of the subsidy burden to ONGC and GAIL, another one-third

through overpricing other products such as petrol and diesel, and the remaining to

40


41/92

be borne by the OMCs. It is estimated that total subsidy burden on account of

under pricing for FY04 stood at Rs.8,200 crore. ONGC and GAIL share was

estimated to be at Rs.2,400 crore.

6.2 Budget proposals

Survey & exploration of minerals have been brought under the service tax net.

Service tax rate has been increased from 8% to 10%.

Education cess of 2% on income tax, corporation tax, excise duties, custom duties

and service tax to be levied. Credit on education cess on duties paid on Motor

Spirit (MS), High Speed Diesel (HSD) and Light Diesel Oil (LDO) will not be

allowed.

Total expenditure of Ministry of Petroleum and Natural Gas (MoPNG) for 2004

-05 is proposed at Rs.3573 crore as against revised estimate of Rs.6903 crore of

2003 - 04.

Equity support of Rs.14,194 crore and loans of Rs.2,132 crore to entral Public

Sector Enterprises (PSEs) in six sectors, including petroleum, is budgeted.

Excise duty on gas stoves with an MRP not exceeding Rs.2,000 per unit has been

reduced from 16% to 8%.

41


42/92

Existing Counter vailing Duty (CVD) exemptions on LNG to continue. Excise duty

of 16 % on LNG has been done away with.

Table no. 1: Changes in duty structure (%)

6.3 Budget Impact on Industries

42


43/92

Levy of service tax on survey and exploration activities would have an adverse

impact on companies in the exploration and production sector.

Reduction in budgetary allocation for MoPNG is likely to increase the subsidy

burden to be borne by oil marketing companies. Further, there is no clarification on

continuation / withdrawal of the three way split scheme for sharing of subsidy

burden on LPG and Kerosene introduced during FY04.

Education cess of 2% is likely to increase the retail price of selected petroleum

products marginally. Further, cess paid on MS, HSD and LDO will not be availableas credit for payment of cess on the final products.

Reduction in excise duty on LPG stoves is expected to increase penetration,

particularly in the rural segment. This is expected to increase consumption of LPG.

Table no. 2 : Budget impact on companies

43


44/92

CHAPTER 7

CRUDE OIL FUTURES

44


45/92

7.1 Introduction

The Indian government has now permitted oil companies in India to hedge against

commodity price risks while importing crude and petroleum products. This initiative has

been taken by the Indian government in a bid to protect the economy from the volatility

of international crude prices. All oil companies having underlying exposures in crude and

petroleum products will now be allowed to import and hedge future prices against the

drastic volatility of the prices in the hydrocarbon sector. This has almost become a

necessity for a country like India, which imports 70 percent of its petroleum requirementand needs to be protected against such price movements in the International oil markets.

Oil companies such as the Indian Oil Corporation (IOC), Reliance Petroleum and

MRPL are expected to be the beneficiaries of this move from the government. The

hedging facility is to be subjected to detailed guidelines to be issued by the RBI and is

expected to make Indian producers more efficient and enable them to compete in the

International markets. The immediate beneficiaries of the decision will be the Industry

experts opinion that hedging instruments which are used for other commodities like sugar

etc. are like insurance, both for the buyer and the seller, while the buyer can protect his

interests by locking future physical deliveries at prices quoted at present, the seller too

can protect his interest by contracting sales at a price which may fall in the consequent

months.

45


46/92

The volatility in the International Oil markets can be gauged by the fact that oilprices have been roller coasting during the period December 1999 and April - May 2000.

The prices in December stood at a historic low of barely $10 a barrel while by April -May

it moved up to over $31 a barrel. In August 2004 it was hovering around $44/ barrel). Oil

companies have gained or lost significantly due to the lack of price risk hedging

instruments and have been unable to protect their future interests.

The hedging mechanism is based on a benchmark crude for which price quotes are

available. Exchanges that trade in oil futures has their own crude benchmarks.

In the oil futures market, the quotes are usually for a period of about six months

and the buyer of the future needs to take a position for a particular quantity to be

physically delivered at a particular point of time. The advantage for the buyer would be

that if prices moved up by the time that the physical delivery of the product takes place,

the buyer is compensated with an adjustment and a settlement with the difference being

paid back. The buyer thus is able to hedge against an increase in the prices of crude and

petroleum products. In the case wherein there is a fall in the prices of crude and

46


47/92

petroleum products then the sellers interest is protected as the delivery is made on the

agreed price by the buyer.

For the Indian market the relevance of the permission by the government allowing

oil companies to hedge against price risks in the crude and petroleum products markets

lies in the facts that :

Large crude buyers such as the Indian Oil Corporation, Reliance Petroleum and

MRPL will be able to improve profitability.

The impact of the volatile international oil prices can be tamed by being able to

hedge against price hikes using oil futures. Lastly this will enable the Indian oil

companies to gear up to competition from global oil players such as Morgan

Stanley and Citibank who are poised the enter the Indian markets.

7.2 Benefits of MCX crude futures

While energy futures markets in the US and Europe trade many times their

underlying oil production and consumption, the need for active energy futures

instruments still exist to a large extent in the Asia - Pacific.

Safeguard mechanisms

The MCX crude Futures will allow oil producers, refiners, traders and consumers

to manage their crude oil price risk with greater precision and without concerns for

47


48/92


49/92

market price. As on date, even the prices of crude bi - products are allowed to vary

+/- 10% keeping in line with international crude price, subject to certain

government laid down norms / formulae. All these facilitates a future trade in crude.

Table no. 3 : International oil price variation

Table no. 4 : Maximum price variation

49


50/92

CHAPTER 8

GOVERNMENT TAXES ON FUEL

8.1 Subsidy allowed on fuel prices

Subsidy on PDS Kerosene and Domestic LPG effective 1.4.2002 is met from the

fiscal budget and has been fixed on a specified flat rate basis for each Depot /

Bottling Plant based on the difference between the cost price and the issue price per

selling unit. The scheme has provided that both the cost price and issue price

would be revised by the companies based on the changes in corresponding prices inthe international market. However, this mechanism could not be implemented by

the companies on account of sharp rise in LPG prices in international markets since

2004 and consequent Government direction to modulate price increases. The

subsidy scheme has been extended till 31.3.2014.

The average subsidy during 2002-03 on PDS Kerosene was Rs.2.45 per litre & on

domestic LPG at Rs.67.75 per cylinder. The flat rate subsidy was reduced by 1/3rd

each year during 2003-04 and 2004-05. Since then the subsidy rate for Domestic

LPG and PDS Kerosene has been maintained at the 2004-05 level (i.e. 1/3rd of

2002-03 level), i.e. 82 paise per litre for PDS kerosene and Rs.22.58/cylinder for

domestic LPG. The Government has made a provision of Rs. 2900 crore towards

subsidy on these products in the fiscal Budget for 2010-11.

50


51/92

Table no. 5 : Subsidy on PDS Kerosene & Domestic LPG under Subsidy

Scheme 2002

Table no. 6 : Subsidy for far - flung areas under Freight Subsidy Scheme

Year PDS Kerosene Domestic LPG Total

2002-03 2098.0 2398.0 4496.0

2003-04 2657.0 3635.0 6292.0

2004-05 1147.0 1783.0 2930.0

2005-06 1057.0 1605.0 2662.0

2006-07 970.0 1554.0 2524.0

2007-08 978.0 1663.0 2641.0

2008-09 974.0 1714.0 2688.0

2009-10 955.6 1814.4 2770.0

2010-11 930.6 1973.6 2904.3

51


52/92

Table no. 7 : Central Excise and custom tariff

52


53/92

Particulars

CUSTOMS CENTRAL EXCISE

Basic

Customs

Duty

Additiona

l Customs

Duty

(CVD)

Additi

onal

Custo

ms

Duty

Basic

Cenvat

Duty

Special

Additio

nal

Excise

Duty

Additiona

l Excise

Duty

Crude Petroleum

NIL + Rs.

50/MT as

NCCD

Nil+Rs.2500/MT

as Cess+

Rs.50/

MT as

NCCD

Petrol

2.5%

Rs.6.35/ltr

. +

Rs.6.00/ltr

SAD

Rs.2.00

/ltr.

Rs.6.35/l

trRs.6/ltr

Rs.2.00/ltr

.

Petrol (branded)

Rs.7.50/l

trRs.6/ltr

Rs.2.00/ltr

.

High Speed Diesel2.5% NIL

Rs.2.00

/ltr.Nil

Re.2.00/ltr

.

High Speed Diesel(branded)

Rs.3.75/Ltr

Re.2.00/ltr.

LPG

Domestic Nil Nil Nil

Non -

Domestic5.0% 8.0% 8.0%

Keros

ene

PDS Nil Nil Nil

Non PDS 5.0% 14.0% 14.0%

Aviation TurbineFuel

Nil 8% 8%

Napht

ha

Non-

Fertilizer5.0% 14.0% 14.0%

Fertilizer Nil Nil Nil

Bitumen &

Asphalt

5.0%

14.0%

14.0%

53


54/92

Table no. 8: Dealers commission on Petrol and Diesel

54


55/92

Table no. 9 : Distributor Commission on LPG

Effective date Petrol Diesel

1-Apr-04 707.0 425.0

21-Jun-05 778.0 467.0

1-Aug-05 848.0 509.0

1-Mar-07 894.0 529.0

16-May-07 1024.0 600.0

23-May-08 1052.0 631.0

27-Oct-09 1125.0 673.0

7-Sep-10 1218.0 757.0

1-Jul-11 1499.0 912.0

55


56/92

CHAPTER 9

Effective date LPG

14.2 Kg. 5 Kg.

As on 01-April-04 16.71 8.60

1-Mar-07 19.05 9.81

4-Jun-08 20.54 10.58

30-Jun-09 21.94 11.30

1-Jul-11 25.83 13.30

56


57/92

IMPACT OF INCREASE IN OIL PRICES ON GROWTH AND

INFLATION LEVELS IN INDIA

The impact of high oil prices on the oil-importing countries can vary, depending on

the level of development and the energy intensity of the economy, as also on the

degree of oil import dependence.

The Government is committed to ensuring high economic growth of the country, to

eradicate poverty and to remove socio-economic imbalances. The experience of

countries like Japan, Taiwan and South Korea has shown how high growth can

eliminate poverty and transform a developing country into a developed one. The

two issues that need to be addressed are:

(i) Sustainability of high growth with moderate inflation.

(ii) Inclusive nature of growth, which means the aam admi should share the

benefits of high economic growth.

Table no. 10 : Impact of oil prices

57


58/92

International

Oil price per

barrel ($)

Increase in

International

Oil Prices (%)

Extent of fall in

manufacturing

Sector growth

(%)

Extent of fall

in GDP

growth (%)

Extent of

increase in

WPI (%)

50 38.9 2.1 0.4 1.5

60 66.7 9.7 1.9 3.

70 94.2 16.9 3.4 5.7

80 122.2 24.5 4.9 7.9

140 126.1 29.7 7.3 7.2

In the last two years, the Indian economy grew by over 9% per annum, with

moderate inflation. Last year, the growth rate was 9.6%, the highest in the last 18

years. Today, India is again poised to achieve double-digit growth.

However, sustenance of this high growth faces the difficult challenge posed by

rising oil prices in the international market. Indias dependence on oil imports,

which is around 75% today, is expected to touch 90% in the next two decades.

Indias gross oil import bill, which stood at nearly one lakh thirty one thousand

crore rupees (Rs.1,31,000 crore) in 2004-05, is expected to be more than double

during 2007-08.

58


59/92

High international oil prices are exerting an upward pressure on domestic prices of

petroleum products. The price of petrol on 31 January 2008 was 43.52 per litre in

Delhi. If the entire burden of rise in international prices is passed on to the

consumer, the price of petrol in Delhi would rise by Rs.8.70/litre. Similarly, the

price of Diesel would rise by Rs.9.60 and PDS Kerosene by over Rs.19 per litre.

Each cylinder of domestic LPG would be costlier by Rs.335. Obviously, full

increase in domestic prices in line with rise in international oil prices would have a

cascading effect on the entire economy. It would bring hardship for the common

man.

To protect the interests of the aam aadmi, consumer prices of PDS kerosene

have not been revised since March 2002. The retail price of LPG has not been

increased since November 2004. The prices of petrol and diesel have remained

59


60/92

unchanged since February 2007. This has led to Oil Marketing Companies

incurring huge under-recoveries on sale of the four petroleum products. These

under-recoveries are projected to exceed Rs.71,000 crore in 2007-08.

Considering the inflationary impact of rising petroleum prices, Government policy

has been to equitably share the burden among the Government and oil PSUs so that

impact of price rise on the people is minimized. While upstream oil companies,

namely ONGC, GAIL and OIL, have been sharing a part of the burden of rising

international oil prices on the oil marketing companies since 2003-04, the

Government has issued special oil bonds to the oil marketing companies.

The burden-sharing mechanism put in place by the Government has insulated the

Indian economy from the inflationary consequences of high oil prices but this can

not be sustained in the long run. To ensure Indias energy security, our oil PSUs are

required to invest about Rs. 2.5 lakh crore in expansion and upgradation plans,

during the XI Plan period. Therefore, a holistic approach is required, which

includes rationalization of costs, including taxes and duties on petroleum products,

and moderate increase in retail prices, keeping in mind the capacity of the

consumer to pay.

CHAPTER 10 :

REAL COST OF PETROL IN INDIA

60


61/92

India has taken steps to de-regularize the petrol prices and increase diesel prices. In effect

petrol and diesel prices are raised. Even after the hike in the four sensitive petroleum

products, government of India still has to under recover 53,000 crore rupees or $11.3

billion. At current international prices the under recoveries of the oil marketing

companies would translate to Rs.17.92 per litre on Kerosene, Rs.261.90 per cylinder

on Domestic LPG and Rs. 1.5per liter fordiesel.

When compared with Indias neighboring countries, the prices of petrol and diesel are

higher but the cost of kerosene and LPG are much lower.

The consumer price of Kerosene in Indias neighboring countries :

1. Rs.35.97/litre in Pakistan

2. Rs.29.43/litre in Bangladesh

3. Rs.21.02/litre in Sri Lanka

4. Rs.39.24/litre in Nepal.

The consumer price of LPG in Indias neighboring countries :

1. Rs.577.18/ cylinder in Pakistan

2. Rs.537.37/ cylinder in Bangladesh

3. Rs.822.65/ cylinder in Sri Lanka

4. Rs.782.84/ cylinder in Nepal

61


62/92

In April 2010, the cost of a liter petrol in Delhi was 47.93 rupees per liter. But as per

the government of India, if it was market determined then it should be 54.61 rupees per

liter. Not sure how the figure of 54.61 was arrived at but at 47.93 per liter the actual cost

of petrol is 26.34 rupees per liter before all the taxes.

Here is the breakdown of the taxes charged by the government in various forms. From the

time it is refined to the time it reaches the consumers.

1. Excise duty : 14.35 rupees per liter

2. Customs duty : 7.5 percent

3. Sales tax or VAT : 20 percent.

Figure no. 4 : Evaluation of petrol and diesel price

62
http://www.pib.nic.in/release/release.asp?relid=62834http://www.pib.nic.in/release/release.asp?relid=62834


63/92

The total taxes amount to 45 percent of the final cost of the petrol . With a

26.34 rupees per liter of petrol if we add all of the taxes it comes to 47.93 rupees per liter,

the cost of petrol in Delhi before the recent hike.

The crude in international market is now at $72.35 per barrel. If barrel is taken to be

158.99 liters then the cost of crude would be some 46 cents which would mean the crude

cost is 21 rupees. And the cost of refining crude should be added up to. The cost of

refining is hard to find out and looking at the difference it should be around 5.34 rupees

per liter of petrol. I somehow find that hard to believe and I thought the cost of refining

would be much higher. Crude goes through a lot to become petrol. Crude Distillation Unit

(CDU), Vacuum Distillation Unit (VDU), Fluid Catalytic Cracking Unit (FCC), Hydro-

cracker, Coker unit, Lube Unit are the several things which crude goes through to become

petrol or diesel.

63
http://pib.nic.in/release/release.asp?relid=63018


64/92

If a barrel of crude oil in International market is $140, as it was in 2008, and if the

petrol prices were left to the market fluctuations then the cost of petrol in retail market

would be 70 rupees per liter. This was exactly the rate at which Shell sold petrol in

2008. Shell is the lone private retailer along with Reliance. Both Shell and Reliance had

shut down many of their shops as they couldnt compete with the government owned oil

marketing companies which were absorbing the shocks. This has done two things. It kept

private sector out of the competition and it has shielded people from price hikes and falls

and inherently made them oblivious to the consumption control. Indias oil

subsidies are 0.4 percent of Indias total budget in 2008.

CHAPTER 11

CHANGE IN PRICE OF CRUDE OIL

64


65/92

Figure no. 5 : Change in crude oil prices and its finished products

CHAPTER 12

PRICE DISCOVERY

65
http://us.asiancorrespondent.com/indianomics/2008/09/11/will-india-remove-oil-subsides-ever/http://us.asiancorrespondent.com/indianomics/2008/09/11/will-india-remove-oil-subsides-ever/http://in.reuters.com/article/asiaCompanyAndMarkets/idINSP5718820080103


66/92

12.1 Introduction

A futures market facilitates offsetting the trades without exchanging physical goods

until the expiry of a contract. As a result, futures market attracts hedgers for risk

management, and encourages considerable external competition from those who possess

market information and price judgment. While hedgers have long-term perspective of the

market, the traders and arbitragers, prefer an immediate view of the market. However, all

these users participate in buying and selling of commodities based on various domestic

and global parameters such as price, demand and supply, climatic and market related

information. These factors, together, result in efficient price discovery.

12.1.1 Background of Pricing Mechanism of Indian Energy Sector

Prior to the Dismantling of Administered Price Mechanism (APM) in 2002 the

Government used to fix the prices of petroleum products therefore the consumers were

shielded against the vagaries of International price fluctuation. In 2002 when APM was

dismantled Oil companies (Producers & Refiners both) as well as consumers became

exposed to the Crude Oil fluctuations in the international market. Therefore the need was

felt to hedge this exposure through trading on Commodity Derivative exchanges .

12.1.2 Advantages /Benefits of Energy Commodity Trading on Indian Exchanges

Traditionally the advantages of trading commodities have Price Discovery and

66


67/92

development of supply chain. Another significant advantage is the Cover from Forex

Exposure Risk because the futures are rupee denominated which is a clear gain over to

trading at Nymex where the players had to look for Forex hedging.

12.1.3 Factors Required for Price Discovery

Presence of players in large numbers and in full spectrum is a very important

factor. In economic terms there should be enough number of buyers and sellers to make it

a Perfect Competition market condition. We need Hedgers for getting the long term

perspective in the market. Again Speculators (also termed as Traders or Punters) are

important for bringing in the immediate picture and trends from the knowledge they are

carrying. Finally Arbitragers are also need to correct any positions of Arbitrage.

12.1.4 Some of the Important Players in each segment can be

Hedgers :

Oil PSUs like IOCL, HPCL, BPCL

Other Petrochemical Companies who use Petroleum Products

Railways, Shipping Companies, Airlines etc

Speculators :

67


68/92

Investment Banks, Brokerage Houses, Foreign Institutional Investors etc

Individual Investors (Transporters, Industrialists, Traders etc)

12.1.5 Other important factors required for price discovery at MCX/NCDEX are:

Market should have enough Volatility to attract hedgers and speculators.

Introduction ofFull Range of Crude Oils.

Use ofAppropriate Marker to avoid Price Premiums.

Availability of Refined product futures to provide forCrack Spread Hedging.

Contracts to be made tailored to meet market Requirements.

Regulatory guidelines & Suitable Accounting Standards and Tax policies.

12.2 Indian Conditions

68


69/92

a. Non-Availability of Full Spectrum of Players :

The PSUs are still reluctant to trade on MCX and NCDEX because of:

No Middle East crude futures on MCX/NCDEX.

Non availability of Refined Product Futures (Like ATF, Naphtha, Fuel Oil).

Limited trading hours of the MCX/NCDEX exchanges.

At present MCX operates from 10 a.m. to 11.30 p.m., this is an anomaly as the

domestic exchange is trading in global commodities.

b. Lack of full Range of Crude Oils Traded on MCX & NCDEX.

c.Lack of Appropriate Marker to any Price Premiums vis--vis any other trading

Markets.

d. Crack Spread Hedging not available because futures for Refined products like

ATF, Naphtha, Fuel Oil etc) are not available for trading. Although prices of Crude Oil

and petroleum products are generally expected to vary on same scale but sometimes they

may behave otherwise. In that situation a Crack Spread arises. E.g. When prices of

Refined products like Petrol have not increased or decreased with same percentage as the

prices of the Crude Oil. Here to hedge his risk on the refined product a refiner has to have

a double hedge in mutually opposite senses. e.g. He may need to have a Long Hedge in

Crude Oil and a Short Hedge in Petrol .

69


70/92

e. Contracts to be made tailored to meet Indian Requirements.

f. Regulatory guidelines for Hedge Funds/Speculators and Hedgers:

As per the guidelines the Oil companies cannot indulge in any sort of speculation

and are allowed only to hedge their risk. The oil companies can presently hedge only

imported crude oil, petroleum products export and refinery margins arising out of

imported crude oil. Unfortunately Freight cost and counterparty risk are still not allowed

to be hedged as yet. The positions permitted are Long on crude and short on products and

crack margins. What is still wanted from RBI is Suitable accounting standards and tax

policies to distinguish hedging from speculative contracts. But some of the good steps

have been making the Board of companies responsible for their trading

Table no. 11 : Factors for Price Discovery on MCX/NCDEX:

70


71/92

12.3 The Issue Of Asian Risk Premium : Dubai Crude Being An

Ineffective Marker

71


72/92

Formula prices of Arabian Light crude for the Asian market have been higher than

those for European/U.S. markets by $1 - 1.5 per barrel over the period of ten years or so.

This differential has an adverse impact on the economic competitiveness of the countries

involved. On the other hand, the formula prices of Arabian Light crude for the European

market had been almost identical with those of the U.S. markets. The price for European

stations is linked to the average spot price of North Sea Brent crude; and that for US

supplies to WTI crude. Prices for supplies to Asia are linked to a 30-day spot average of

Oman and Dubai crude during the month of delivery.

Major reason attributed for the above is lack of strong trading markets in Asia.

Again the production of Dubai crude was more than 400,000 b/d in the latter half of the

1980s, but began decreasing in the 1990s to drop to the current level of merely 170,000

b/d. It is difficult to determine the price of Dubai crude on spot trading at present because

of the decline in Dubai production.

Table no. 12 : World Oil Demand 2010

72


73/92

12.4 Solutions to the problem of Asian Risk Premium

12.4.1 Case for Greater Asian Bargaining power for a better Price

Marker

As evident from the following table growth in Asia led by China, India and

other South East Asian nations has led to a total change of position. Gradually since

the1980s growth has been led by Asian nations. Only Asian demand growth is 15% for

China whereas OECD countries are generally stagnant . This can be used to bargain a

better crude marker for Asia as the markers have been decided by the OPEC on the basis

of consumption and buying power.

73


74/92

We can solve for the problem of a viable marker by choosing a new marker for

Asia. Yoshiki Ogawa in his paper of November 2002 titled Proposals on Measures for

Reducing Asian Premium of Crude Oil (The Institute of Energy Economics, Japan) has

suggested use of the following as the alternatives Daqing Crude of China, Arabian Light,

Price Index of Middle East Crude, Oman Crude, IPE Brent, Average of the current

formula prices for the European and the U.S. market. Of these only the last three have

been considered as viable yet temporary alternatives. Finally the point that is brought

home is that all Asian Nations have to work towards developing the Asian markets into

effective trading hubs on the lines of Simex of Singapore and Tocom of Japan.

12.4.2 Making Effective Price Discovery in Asian Markets by developing

them

Despite the size and importance of Asian market, pricing of oil in the continent is

dependent on less-than-satisfactory crude pricing markets, namely Tapis, Minas andDubai, making market signals not very efficient. No market except TOCOM figures in

the list of top 10 commodity exchanges of the world Therefore the need is for the Asian

countries to come together to develop stronger markets with following characteristics:

It is important for the success of Trading Markets that the governments should

deregulate the markets .It is anomalous in India that despite the dismantling of

APM prices of high consumption products like Petrol , Diesel, LPG are still highly

regulated.

Price Transparency is high.

74


75/92

Trading is done in variety of Contract types like Cargoes, Barges etc

Final product price is formed of both Spot and Future trading and Crude Oil

Product prices should affect each other leading to real price discovery.

12.5 Need For Supply Chain Efficiencies

It is a pity in Asia that despite using the Middle East Crude in huge quantities the

cost of transportation and storage is very high. Transportation cost between the Middle

East and rest of the Asian countries is still to be reduced. This is one of the structural

factors leading to relatively higher crude oil prices for the Asian market. Another

facilitating factor here can be building storages in large- demand countries to ensure that

there is no shortage of fuel even during disruptions and emergencies.

12.5.1 Case of other Markets

75


76/92

a) Lessons form the experience from Japans Biggest Commodity

exchange Tokyo Commodity Exchange, TOCOM.

In 1999 the first energy contracts, gasoline and kerosene, were listed on TOCOM

these products proved tremendously successful with the local trading community. They

are domestic commodities and dont have any equivalent or mirror markets overseas. The

trading style is to forcefully push a market, a technique that is less successful with

international commodities, where arbitragers quickly move the markets back to

equilibrium. In India although price of Petrol , Kerosene etc are presently determined by

the government but if we wish the Indian commodity markets are to succeed in real terms

and attain global hues then all the products including these along with popular Crude

varieties have to be trade .

Following regulations have been advocated at TOMCO especially for regulating the trade

done by speculators through brokers.

i. Margins are to be deposited fully and directly with exchanges. MCX in India

has kept the margin value at 5%.

ii. Segregation of clients funds at brokers must be reinforced.

iii. Stricter Surveillance of broker fund management is to be implemented.

iv. A centralized clearing system is to be made possible.

76


77/92

v. Margin calculations to be rationalized , reflecting real time market risk.

b) Lessons from Singapores Commodity exchange Simex

Spot market at Singapore developed as a result of excess supply which is a key

ingredient for the development of a spot market. Spot trading started off with players

trading based on refinery posted prices up to late 1980s. After that increased arbitrage

opportunities to Asia and the surplus production in Singapore speeded up the

development of spot trading. Later on the factors that facilitated growth of futures trading

were arrival of western traders and the establishment of independent storage facilities.

Supply Chain efficiencies in terms of storage and transport emerged as Singapore

is situated along major Asian and trans-Pacific trade routes. Singapore gradually

developed storage facilities of about 87.77-mil bbl which is very competitive by world

standards. Good storage capacity allows players to capture contango and allows players to

optimize trading positions. Finally Singapore governments Hands-Off policy has really

paid in developing a competitive market.

RECOMMENDATION

A] Petrol

77


78/92

Petrol is largely an item of final consumption. Its price, therefore, has a very small

impact on inflation due to forward linkages.

Table no. 13 : Average annual use of petrol per vehicle

Type

of

Vehicle

Average

Distance

Covered

annually (KM)

Fuel

Efficiency

(KM/Litre)

Litres/

Vehicle/

Year

Monthly Fuel

Cost at price

on 1.1.10 in

Delhi (Rs)

Two Wheelers

(Petrol)

6300

(10000)

73.0 86 320

Three Wheelers

(Petrol)

35000

(40000)

34.0 1,029 3835

Cars(Petrol)

8000(15000)

13.5 593 2210

Cars

(Diesel)

8000

(15000)

14.0 571 1566

MPV

(Diesel)

7800

(37000)

8.7 897 2461

Bus

(Diesel)

55000

(60000)

4.1 13,415 36802

Heavy Trucks

(Diesel)

55000

(35000)

3.6 15,278 41913

Light Trucks

(Diesel)

20000

(40000)

4.5 4415 12112

78


79/92

A two-wheeler consumes, on an average, 86 litres of petrol per year, for which the

owner spends Rs. 320 per month (Rs. 510 in Delhi). The fuel expenditure of car

owners is much larger at Rs. 2210 per month (Rs. 4140 in Delhi). Motorizedvehicle owners are largely well-off persons belonging to the upper two/three

deciles of the population. There is no reason to subsidize this class of consumers.

Full price pass-through at US $ 80/bbl will increase the retail price of petrol by

around Rs.7/litre. The additional expenditure of a two-wheeler owner would be

only Rs. 50 per month (all-India average). Even for two-wheeler owners in Metro

Cities who drive more (around 10000 KM per year), the increase on fuel

expenditure will be around Rs. 80 per month. Even if the crude price increases to

$120 compared to the present price of around $70/barrel, the retail outlet price of

petrol, assuming the current tax regime, will increase by Rs. 23/litre (i.e.,

Rs.20/litre on the basis of rise in indicative selling price of petrol from $70/bbl to

$120/bbl of crude price + Rs.3/litre on account of the current price being below the

estimated indicative selling price) and the additional expenditure , assuming no

reduction in use, will be around Rs. 160/month on a two-wheeler user and less than

Rs. 1000/month on a private automobile user (at all-India level)

If higher petrol prices lead to less driving, more fuel efficient vehicles and an

efficiency increase by 20%, the additional cost would be that much less.

79


80/92

The cost increases can be borne by motorized vehicle owners and recommends that

petrol prices should be market-determined both at the refinery gate and retail

levels.

B] Diesel

80


81/92

The consumption of diesel by different users in 2008-09 has been shown in Figure.

Trucks accounted for 37% and buses 12% of total diesel consumption in 2008-09.

Agricultures share was 12%.

Figure no. 6: Consumption of diesel by different users

The burden of diesel price increase on agriculture depends on where it is used. In

2008-09, 12 % of total diesel went to agriculture (i.e., to tractors, thrashers, tillers,

81


82/92

harvesters, pump sets etc.). The cost of diesel in agriculture would be accounted for

by the Government while fixing the Minimum Support Price (MSP) for major

crops. Therefore, any increase in the cost of diesel will be reflected in the price and

will not adversely affect farmers. However, those who use diesel relatively more

may not get fully compensated by MSP. Higher diesel price will induce them to use

less diesel which may reduce over-use of ground water prevalent in many parts of

the country. Of course, higher diesel price resulting in higher MSP will increase

subsidy for PDS, but it would be much less than the reduction in under-recovery on

diesel.

Trucks and LCVs consume around 40% of diesel. It is reported that with industrial

revival and higher economic growth, the truck owners generally raise their rentals

in consonance with growth. Therefore, long distance charge for a round trip

between Delhi and Mumbai for a 9-tonne truck is more than Rs. 40000 today

whereas its diesel consumption works out to around Rs. 22000. Higher diesel price

would encourage fuel use efficiency as well as greater use of railways for freight

movement. Railways consume around 1/4th as much diesel per net tonne kilometer

as trucks.

Even assuming that the truckers, power generators, industrial users etc.(other than

the passenger car owners) are able to pass on fully the additional cost of diesel, an

increase of Rs. 4 per litre would mean an increase of around Rs. 20,000 crore in

their cost of diesel which would be around 0.4 % of GDP in 2008-09. This should

be compared with the inflationary impact of subsidies, which would be similar.

82


83/92

Car owners who drive diesel vehicles, including Sports Utility Vehicles (SUVs),

should be able to bear the additional cost. There is no economic or social reason to

subsidize them.

Thus the price of diesel should also be market determined both at the refinery gate

and retail levels.

With deregulated oil prices, once households and firms clearly see that

international factors drive domestic petroleum product prices, and when monetary policy is seen to emphasize price stability, households and firms would be

relatively relaxed. When there is a temporary shock to oil prices, they would be

much less likely to react to short-term fluctuations in prices through wage

Hikes or increases in product prices. Thus, in OECD countries, from 1979

onwards, where central banks have shifted into de facto or de jure inflation

targeting, the great commodity inflation from 2002 onwards did not pass through

into broad-based inflation in the 2002-2008 period.

Petrol and diesel used in cars, including SUVs, are for final consumption. The

higher excise duty on petrol compared to diesel encourages use of diesel cars.

While greater fuel efficiency of a diesel vehicle should not be penalized, a way

needs to be found to collect the same level of tax that petrol car users pay from

those who use a diesel vehicle for passenger transport. An additional excise duty on

a diesel vehicle corresponding to the differential tax on the petrol should be levied.

At the present excise rates, the additional excise duty paid by a petrol vehicle

83


84/92

owner who on an average drives 8000 KM/year and gets an average mileage of

13.5 KM/litre is around Rs.10000 per year. The present discounted value at 10%

discount rate over the 10-year life of a vehicle would be around Rs. 67,500, and at

5% discount rate it would be Rs. 81,000. An appropriate discount rate would be the

rate on Government bonds. An additional excise duty calculation based on the

following model, adjusted for the existing differential, if any, in excise duty

between petrol-driven cars, and diesel-driven cars, should be levied on diesel car

owners.

At the present rates and a discount rate of 5 per cent, an additional excise duty of

Rs. 80,000 should be levied on diesel driven vehicles. Some persons may still opt

for a diesel vehicle if they expect to drive much more than an average petrol

vehicle owner does

CONCLUSION

84


85/92

Indias imports of oil are increasing. Our import dependence has reached 80 per

cent and is likely to keep growing. At the same time 2008 saw an unprecedented rise in

oil price on the world market. Oil price volatility has also increased. Though future oil

prices are difficult to predict, they are generally expected to rise. Given our increasing

dependence on imports, domestic prices of petroleum products have to reflect the

international prices.

The Government has not permitted public sector oil marketing companies to pass

global prices to domestic consumers. We have examined the impact of the formula-based

prescriptive pricing of major petroleum products devised by the Government from time to

time, particularly since 2002. The present system of price control on petrol and diesel in

particular has resulted in major imbalances in the consumption pattern of petroleum

products in the country, and has put undue stress on finances of the PSU oil marketing

companies as well as of the Government. It has also led to withdrawal of private sector oil

marketing companies from the market. This has affected competition in the domestic

petroleum product market.

Intervention through price control necessitates that someone bears the financial

costs. The issue therefore is to assess the costs and incidence of the burden of alternative

mechanisms on different groups in the society. On whom the burden falls depends on the

policy and the instruments used.

A viable long-term strategy for pricing major petroleum products is required. A

viable policy has to be workable over a wide range of international oil prices and has to

85


86/92

meet the various objectives of the government. It should limit the fiscal burden on

government and keep the domestic oil industry financially healthy and competitive.

The petrol is largely an item of final consumption. An analysis of the trend of

petrol consumption by the automobile owners reveals that increase in prices of petrol can

be borne by motorized vehicle owners. Accordingly, we recommend that petrol prices

should be market determined both at the refinery gate and at the retail level.

Petrol and diesel used in cars, including SUVs, are for final consumption. The

higher excise duty on petrol compared to diesel encourages use of diesel cars. While

greater fuel efficiency of a diesel vehicle should not be penalized, a way needs to be

found to collect the same level of tax that petrol car users pay from those who use a diesel

vehicle for passenger transport. An additional excise duty, based should be levied on

diesel car owners.

The researcher examined that implications of increase in retail price of diesel on

various groups of consumers and do not find any compelling reason to subsidize them.

Therefore, we recommend the price of diesel should also be market determined both at

the refinery gate and at the retail level.

APPENDIX

86


87/92

Interview

A) Ravi Auto Services, Worli, Mumbai 30.

1. What is the retail price of fuel made up of?

A : The price of fuel at the retail station comprises the product cost, central government

excise and taxes, State government taxes and operating costs and margin.

2. Who controls pump prices In India?

A : In India there is no regulated pricing as the Administered Pricing Mechanism was

dismantled in 2001. However, the artificially low pump prices of petrol and diesel do

not reflect the realities of the high crude and refined product prices. The low prices are

subsidized by the present government through the issuance of oil bonds, which are

given exclusively to public sector fuel retailers in India.

For us ,the pricing decision is influenced by a number of factors including:

cost of bringing the fuel to the retail site (product and distribution costs)

cost of running the service station (e.g. salaries, rent, utilities)

3. Why have fuel prices increased compared to previous years?

A : The cost of crude oil and refined product have risen and therefore fuel prices have

increased. The cost of crude oil and refined product are influenced by a number of

factors, such as increasing oil demand, limits in refining capacity, seasonal demand for

product and extreme weather events that have affected refineries or fuel supplies.

4. Why do fuel prices vary in different countries?

A : The price of fuel in different countries is affected by:

87


88/92

Cost of buying finished product in the country

Government excise and tax rates

Government subsidies for fuel

Currency fluctuations

5. How does the US exchange rate affect fuel prices in my country?

A : Since the world's major crude oil market is generally traded in US dollars, any

variation between a country's exchange rate and the US dollar will impact the cost of

buying crude oil in that country.

B) Mr. G. Chandrashekhar, Associate Editor of "The Hindu Business

Line" newspaper.

1. With fluctuation in the international oil prices, how the price discovery takes

place in India?

A : India is a large importer of crude (159 million tons worth $ 80 billion in 2010); there

is n

oil sector - pricing of oil in india

Documents