By Arun Narayanan, Aerospace & Defence Practice, South Asia & Middle East The Indian Aviation Turbine Fuel (ATF

) market is highly controlled and one that is the monopoly of State Oil marketing companies. Additionally, across states, the ATF market (otherwise also known as Aviation Jet Fuels), has a high variable tax structure. ATF pricing in India has traditionally been determined by the Government under the Administered Price Mechanism (APM). APM typically meant that the Government fixed the price of the products and ensured that the oil companies achieved a fixed level of profitability subject to their achieving their specified capacity utilization. In April 2001, the Government dismantled the APM and oil companies were given the freedom to price ATF based on input costs and world market prices. However, despite the withdrawal of APM, the price of ATF in India continues to be much higher than the prevailing international prices. This is primarily because of: Irrational tax structure Cartelization of oil PSU's and monopoly of pricing Existing ATF Pricing Mechanism in India The price of ATF in India is based on International Import Parity prices. However, the ATF supplied by Indian oil companies is refined in India from imported crude. There is no direct import of ATF. The import duty on ATF is 20 percent but the import duty on crude is only 10 percent. Still, the oil companies charge a 20 percent add-on to the Refinery Transfer Price (RTP). Apart from this, oil companies also include a 16 to 49 percent add-on towards marketing margins and contingencies on the Refinery Transfer Price after the addition of the import parity add-on. This add-on varies between various cities. On this, the Central Government levies an excise duty of 8 percent. On the resultant price, the various State Government levy local sales taxes ranging from 4 to 39 percent, which on an average work out to 25 percent countrywide. The total Government levies thus work out to an add-on of 35 percent. Thus, effectively the price of ATF in India works out 60 to 70 percent higher than international benchmarks. Chart 1: ATF Pricing Structure

Source: Frost & Sullivan Chart 2: Comparison of domestic and international ATF prices

Source: Frost & Sullivan The sales tax structure between different states in India also varies greatly. Andhra Pradesh is the only state, which has slashed the ATF tax rate to 4 percent. Maharashtra has also reduced the tax to 4 percent but this is not applicable in Mumbai and Pune, which are its major airports. The Sales Tax on ATF is highest in Gujarat at 30 percent. This effectively means that Hyderabad is the only major metro in India where the state sales tax on ATF is at an acceptable rate. Chart 3: Comparison of ATF tax structure in different states

Source: Frost & Sullivan Differential Pricing Mechanism of Aviation Fuel for Domestic & International Operators The Association of European Airlines (AEA) members indicate that their fuel bill constitutes 13.3 percent of their total operating expenses whereas for Indian carriers the fuel bill constitutes about 45-50 percent of the operating expenses. Even for international operations, the price applicable to Indian carriers' uplifts is higher than those applicable to foreign carriers by 25 percent. Domestic operators pay a 51 percent higher price than what is paid by international carriers in India. Despite the robust growth in demand, the airline industry in India is facing huge losses due to various domestic and external factors. Excessive taxation is one of the prime factors. It is estimated that Indian carriers lost US $500 million last year due to irrational

ATF pricing. As per industry estimates, the projected losses for 2008-09 would be in the range of US $1.8 Billion. Such losses are expected to have far reaching consequences on the operators. Low cost carriers (LCCs) may even have to close down many routes and streamline frequencies. Even Full Service Carriers (FSCs) will have to rationalize their operations. Chart 4: Drivers and Restraints of Aviation Fuels Market

Source: Frost & Sullivan analysis Options for the Indian Aviation Fuels Market (a) Open Access System Apart from taxation, the other major factor leading to high ATF prices in India is the monopoly of oil PSU's at airports. One of the models proposed to prevent this monopolization is the Open Access System also known as Open Sourcing. This model would allow all eligible players to sell their products from common facilities, ensuring full competition on the supply side. At the Bangalore International Airport (BIAL), the common aviation fuel infrastructure, that is, receiving facilities, tanks, hydrant system etc. are operated by a consortium led by Indian Oil Sky Tanking on a Build Own Operate Transfer (BOOT) basis. Into-plane fuelling service is provided by BPCL STARS and Indian Oil Sky tanking. The throughput charges would be fixed at approx Rs.600/kilolitre (US $14 {INR 42.8 to $1}). In Hyderabad, GMR has built the common fuel facilities, which would be operated by Reliance Industries. The Open Access System is expected to be adopted in due course of time at Mumbai, Delhi, Kolkata and Chennai, and the upcoming Greenfield airports too. Reliance Industries Limited (RIL) and Essar Oil have been among the earliest to spot opportunities in this sector. RIL refines 2.95 million tons of ATF per annum at its refinery in Jamnagar, while Essar Oil refines 1.44 million tons. All of this is currently being exported. The profit margins are higher for selling in the domestic market and therefore, with the adoption of the Open Access System, these players are keen to market their products in India. (b) Hedging Recently, the Indian Government has also allowed domestic airlines to hedge fuel risk. The Multi Commodity Exchange of India (MCX) would introduce trading in ATF futures, which would help airlines hedge abroad. Hedging allows carriers to insulate themselves against rising fuel prices and maintain stable profitability. It also helps airlines generate more stable cash flows and better predict future cash flows and earnings. This increased

stability is generally viewed positively by investors, and this leads to higher average price of the stock in the market often called the 'hedging premium'. With fuel costs amounting to more than 40 percent of the operating costs for airlines in India, and more airlines looking at the equity market for financing their fleet acquisition and expansion plans, hedging is likely to be perceived as a useful tool to prevent escalation of costs. (c) Co Branding / Co Marketing of Aviation Fuels can be a win-win solution for the beleaguered Oil companies and airline operators. ATF attracts a duty of 20 percent; on this even if the average taxation of 20 is added, it is still a relatively cheaper option. (d) Sharing of Distribution Network and Infrastructure of the Oil Marketing firms can eliminate overhead channel costs. Challenges for the sector For single location refiners, the distribution of their products would be a challenge. Transporting of ATF and making it available for airports across the country can be a logistical nightmare in India unless companies have the right-tie ups. Co-branding is an option for private suppliers. Oil PSU's normally tie up with each other for product-swaps. Another challenge for private enterprises would be to achieve meaningful volumes for sustainable operations. The Open Access System is relatively new, and unless this model is adopted for airports across the country, oil PSU's will continue to monopolize the nonmetro airports. The marketing margins are also higher for ATF compared to other fuels. However, this can be offset by achieving sufficient volumes. Conclusion The demand for air travel in India is rapidly increasing. Numerous players are entering the airline market resulting in new competitive business models and an explosive growth in capacity. More than 500 new aircrafts have been placed on order by airlines and these aircrafts would be delivered in a phased manner in the coming decade. ATF consumption in India was about 4 million tons in FY07 and is expected to grow at a rate of 15 percent per annum. A booming aviation market and proactive civil aviation policy of the Government are attracting private players. It is the time for the emergence of a dynamic Aviation fuels trading market in India. For more information, please contact, Ravinder Kaur, Corporate Communications, at P: 044 4204 4760 M: +91 99401 41714 or ravinder.kaur@frost.com

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