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Microeconomics Project Report

on
An economic analysis of public sector oil
and gas companies in India

Submitted by:

Williams Charles
Avinash Kumar
Arun Lahoti
Saurabh Mishra
Abhiroop Mukherjee
Amartya Sen

G034
G040
G042
G055

Microeconomics

INTRODUCTION
Scenario of Oil and gas sector in India
Oil and gas constitutes one of the six key industrial sectors of India. Its role is of
strategic importance and a major influencing factor in the national economic
decision making. The demand for oil and gas in India is constantly on a rise and it
is estimated that the oil and gas industry will be worth US$ 139,814.7 million by
2015. With India focusing towards make in India, its economic growth can be
closely linked to increasing demand for oil and natural gas.

Energy consumption mix

Gas consumption is likely to expand at a CAGR of 21 per cent during FY08


17.

India is the fifth-largest LNG importer in 2013, accounting for 5.5 per cent of
global imports.

LNG imports are forecasted to increase at a CAGR of 33 per cent during


201217.

Source: Reference No. 6

Demand for primary energy in India is to increase threefold by 2035 to 1,516


Million Tonnes of Oil Equivalent from 563 Million Tonnes of Oil Equivalent in
2012.

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

With boost from new oil fields, Domestic oil and gas production is expected to
grow to 1 MBPD by 2016.

Source: Reference No. 6

There are public and private organizations like ONGC, HPCL, BPCL and reliance
which does the exploration and production of natural resources to fulfil Indias
energy demand. One such major contributor is the IOCL (Indian Oil Corporation
Limited).

IOCL (Indian Oil Corporation Limited)


According to Fortune 500 Global list of companies, IOCL ranks 119th all over the
world. Indian Oil holds almost 50% market share in petroleum products and 31%
share in refining capacity. The IOCL and its subsidiaries own and operate 10 of
India's 22 refineries with a combined refining capacity of 65.7 million metric tonnes
per year.
IOCL aggressively plans to set to spend about Rs 45,000 crore over the next
three years to build petrochemicals plants and LNG terminal, lay pipelines and
upgrade its refineries in India.
But despite all these expansion measures IOCL had been facing some
challenges. Its performance over the previous Q2 and Q3 had been sluggish and it
incurred huge losses.

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

So, with the upcoming expansion plans it will be a challenge for IOCL to not just
increase its operational efficiencies but to turn to profits and live up to its
Maharatna status.

Financial trend

IOCL incurred a loss in their 3 rd quarter of financial year 2014-15 of Rs.2,636.80


crores with the revenue (net sales) of Rs.1,06,927.34 crores. 1 The previous
quarter i.e. the 2nd quarter of FY2014-15 the loss incurred was Rs.898.46 crores
with a revenue to Rs.1,11,663.81 crores.2
The profit function is dependent on total revenues and the costs. The same can
be represented by the following equation;

Profit = TR Tc
Tc = TVC + TFC
T R = SP * Q

TVC = Total variable cost

TFC = Total fixed cost

TR = Total Revenue

SP = Selling price of crude oil

Q = Quantity sold

So we get profit as,


Profit = SP*Q + TVC + TFC
So as per the formula, profit is directly affected by the changing of any of the
three variables TVC, TFC, TR. The loss incurred can be attributed to reduction in S P
or Q, or increase in the TFC or TVC.

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

Reduction in selling price of fuel


The reduction visible in the net revenue from the 2 nd to the 3rd quarter can be
attributed to the fall in the quantity demanded or to the fall in the prices. But as the
consumer is highly inelastic the quantity demanded fluctuates marginally, so the
fall in the revenue of was due to the dropping of the prices. The selling price of the
finished petroleum products such as petrol, diesel etc. is dependent on the
following factors:

Cost of crude oil (C)


Cost of refining (R)
Taxes imposed (T)

So the net price is given by


N = C+R+T
Where N is net selling price
The other factors like the cost incurred in refining of the crude oil will be nearly
constant as the period under consideration short term. Also the taxes remained
constant during the period, so the fall was only due to change in crude oil price.

Avg. Crude oil Price (US D)/barrel

Profit After Tax (Rs . in Cr)

Source: Reference No. 7

Reasons for reduction of crude oil price

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

The price of the crude oil ,which was $114 per barrel in June,2014,has fallen
down to around $43.55 per barrel. They are in fact at its lowest level which is not
seen in more than 5 and half years. This has significantly caused the price of the
petroleum to fall and IOCL faced a direct impact of this in the form of loss of
revenues.
The decrease in the prices of crude oil could be attributed to the following facts.
1. Huge non-traditional hydrocarbon sources especially shale reserves were
discovered in North America. As the crude oil prices rose, production of
shale oil whose production is otherwise considered non-viable became
attractive and it increased significantly. So, this increase in demand of the
alternate source of crude oil led to the decrease in the price of the crude oil
supplied in OECD.
2. This increase in the overall production did not provoke the OECD countries
to cut down their production. They continued to keep their price low. The
reason behind this was to make the shale gas producers to increase their
production further. The plan is to lead the Shale gas producers to become
unviable because they have to sell it at a lower price competitive to crude
oil. Therefore this situation has led to a great rise in the non-OECD
inventories which are very good indications of an extremely well supplied
market.

Equilibrium price change due to supply curve shift

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

Therefore the huge increase in overall supply of the Oil, with demand remaining
the same have led to a decrease in the equilibrium market price. Hence this has
led to the reduction in the overall revenues of IOCL.

Change in Variable Costs


The increased supply of crude oil in the market led to the inventories of the IOCL
to increase. The following graph shows the increase trend of the inventory cost.

12000
10000
8000
6000
4000
2000

Profit After Tax (Rs. in


Cr)
Changes in
Inventory (Rs in cr.)

0
-2000
-4000

Source: Reference No. 7

The increase in the variable costs also added to the loss of IOCL.

Change in Fixed Cost


In the early part of FY14 following investments were made by IOCL which led to
the increase in fixed cost. Hence, increasing the total cost even though its value
addition towards revenue generation was not seen immediately. This could be
reflected in the losses suffered by it in the Q2 and Q3. The costs incurred are
given below.

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

Refineries5: There was a shutdown of Mathura Refinery for a period of 45 days


for project related activities hence IOCL incurred some costs in it.
Retail Network5: 478 distributorships were commissioned during the year to for
expansion of retail network
R&D5: IOCL invested a lot in research activities filing 54 new patents, surpassing
the previous year's record of 52 patents. Eleven patents were granted during the
year and thus making the number of patents owned by the Centre to 292.
Expanding Business: Apart from refining, transportation and marketing, it has been
working towards strengthening its presence in the oil & gas value chain. The
diversity in businesses has made the Corporation's portfolio more vibrant and has
begun contributing to its bottom-line. During the year, the Corporation's
endeavours in the petrochemicals front has helped it extend its frontiers with the
commissioning of 138 kta Butadiene Extraction Unit (BDEU) and 120 kta.
Styrene Butadiene Rubber (SBR) plant at Panipat. The Corporation is also setting
up its maiden 5-million tonnes per annum LNG import, storage and regasification
terminal at Ennore, which is set to be completed in 2016-17. The work is going on
in three pipeline projects being implemented through two JVs (GSPL India Gasnet
Limited and GSPL India Transco Limited)

Government policies undertaken


The government framed many policies to try reduce the losses of IOCL. The
government increased the import duty from 2.5% to 7.5%. 3 The increase in the
import duty affects the cost price of crude oil which affects the petrol and diesel
prices. The oil sector companies imported around 80% of crude oil and the rest
from domestic producers. The increase in the selling price of fuel created more
profit from the domestically sourced crude oil. Thus the government tried to
increase the domestic production of crude oil by the following policies:

The Policy on Shale Gas & Oil, 2013 4: Facilitates companies to apply for
shale gas and oil rights in their petroleum exploration licenses and
petroleum mining leases. This has allowed companies such as ONGC to
acquire new oil mines which provides oil to IOCL as discounted rates hence
helping it reduce losses and import taxes.

Shale Gas & Oil Exploration Policy4: Approved in September 2013, it


allows companies to explore energy resources present within rocks to meet

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

Indias growing energy needs and hence increasing the availability of


domestic oil and gas.

Supportive FDI policies4: Cumulative FDI inflows in petroleum and natural


gas sector stood at USD6.6 billion (2.5 per cent of total FDIs). In Oil & Gas,
FDI inflows totalled $ 6.6 billion and $ 5.5 billion in FY15 and FY14,
respectively Between FY10 and FY16, FDI inflows into petroleum and
natural gas rose at CAGR 16.06 per cent. This has led to increase in the
revenue margin and reduce losses as procurement of raw material i.e. oil
and natural gas.

All these policies adopted by government has push the supply of oil and gas
thereby affecting the price.

References
1. IOCL financial result Quarter 3 FY 2014-15 :
https://iocl.com/downloads/q3_1415_results.pdf
2. IOCL financial result Quarter 2 FY 2014-15 :
https://iocl.com/Indian_Oil_Corporation_Ltd_131114_q2results.pdf
3. Increase in excise duty:
http://www.thehindu.com/news/national/excise-duty-on-petrol-dieselhiked-no-price-cut/article6794168.ece
4. New policies framed: http://www.ibef.org/download/Oil-and-GasAugust-2015.pdf
5. Annual report
6. Energy consumption mix: http://www.ibef.org/industry/indian-oil-andgas-industry-analysis-presentation

An economic analysis of public sector oil and gas companies in India Case of IOCL

Microeconomics

7. Crude oil price, Profit after tax, Inventory cost:


https://www.iocl.com/aboutus/financialperformance.aspx,
http://www.infomine.com/investment/metal-prices/crude-oil/1-year/,
http://www.infomine.com/investment/metal-prices/crude-oil/5-year/,
http://www.indexmundi.com/commodities/?commodity=crudeoil&months=60&currency=inr

An economic analysis of public sector oil and gas companies in India Case of IOCL

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