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INDEX Sr. No
Topic INTRODUCTION 1.1 1.2 1.3 Research Objective Research Methodology Review of Literature
Page No 1–4
INDIAN CRUDE OIL MARKET 2.1 2.2 2.3 Historical Background Production of crude oil in India Indian Energy Industry Structure
5 – 12
OIL PRICING POLICY IN INDIA 3.1 3.2 Facts and Figures Latest development
13 - 17
FACTORS INFLUENCING OIL PRICES IN INDIA ROLE OF GOVERNMENT IN OIL SECTOR 5.1 5.2 Policy Initiatives Opportunities
18 – 20
21 – 24
IMPACT OF UNION BUDGET 6.1 6.2 6.3 6.4 Background Budget Proposals Budget Impact on Industries Budget impact on companies
25 – 29
CRUDE OIL FUTURES 7.1 7.2 Introduction Benefits of MCX crude futures
30 – 34
GOVERNMENT TAXES ON FUEL
35 – 42
8.2 8.3 8.4
Subsidy allowed on fuel prices Central Excise and custom tariff Dealers commission on Petrol and Diesel Distributor Commission on LPG
IMPACT OF INCREASE IN OIL PRICES ON GROWTH AND INFLATION LEVELS IN INDIA
43 – 46
REAL COST OF PETROL IN INDIA
47 – 50
CHANGE IN PRICE OF CRUDE OIL
51 52 – 63
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
64 – 70 71 – 72 73 – 75 76 - 78
LIST OF FIGURES
Sr. No 1 2 3 4 5 6
Topic 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
Page No 10 11 20 49 51 67
LIST OF TABLES
Sr. No 1 2 3 4 5
Topic 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
Page No 27 29 34 34 36
7 8 9 10 11
38 – 40 41 42 44 57
WORLD OIL DEMAND 2010 AVERAGE ANNUAL USE OF PETROL PER VEHICLE
59 64 - 65
Oil is vital to the world economy and the world consumption of oil, driven by countries 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 nonrenewable 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
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 price increases 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
grains and vegetable oils and also that over the longer term, high energy prices tend to affect food prices through the biofuel channel
LIST OF ABBREVIATIONS
OPEC E&P R&M ONGC IOC HPCL BPCL CPCL BRPL NRL MRPL IGL LNG : Organization Of Petroleum Exporting Countries : Exploration and Production : Refining and marketing : Oil and Natural Gas Corporation Limited : Indian Oil Corporation Limited : Hindustan Petroleum Corporation Limited : Bharat Petroleum Corporation Limited : Chennai Petroleum Corporation Limited : Bongaigaon Refinery & Petrochemicals Ltd. : Numaligarh Refinery Limited : Mangalore Refinery and Petrochemicals Limited : Indraprastha Gas Limited :. : Liquefied natural gas
L&T IBP KRL RPL RIL APM GDP WPI NPL LPG FDI LNG US OMC’s
: Larsen and Toubro : Indo-Burma Petroleum Company : Kochi Refineries Ltd : Reliance Petroleum Limited : Reliance Industries Limited : Administered Pricing Mechanism : Gross Domestic Product : Wholesale Price Index : New Exploration Licensing Policy : Liquidified Petroleum Gas : Foreign Direct Investment : Liquefied natural gas : United States : Oil marketing companies
MS HSD LDO
: Motor Spirit : High Speed Diesel : Light Diesel Oil
MoPNG : Ministry of Petroleum and Natural Gas PSEs MRP CVD RBI MCX PDS CVD VAT CDU VDU : Public Sector Enterprises : Maximum Retail Price : Counter Vailing Duty : Reserve Bank of India : Multi Commodity Exchange of India : Public Distribution System : Central VAT Duty : Value-added tax : Crude Distillation Unit : Vacuum Distillation Unit
: Fluid Catalytic Cracking Unit
NCDEX : National Commodity and Derivatives Exchange of India PSU ATF IEEJ : Public Sector Undertaking : Airline Turbine Fuel : Institute of Electrical Engineers of Japan
TOCOM : Tokyo Commodity Exchange SIMEX KM MVP Bbl MSP LCV’s SUVs : Singapore International Monetary Exchange : Kilometer : Multi purpose vehicle : Barrel / liter : Minimum Support Price : Light Commercial Vehicles : Sports Utility Vehicles
: International Energy Agency
NYMEX : New York Mercantile Exchange PPAC MOSPI : Petroleum Planning and Analysis Cell : Ministry of Statistics and Programme Implementation
CHAPTER 1 INTRODUCTION
Oil is the single most important commodity that holds the position of a key factor in each and every economy of the world. The world’s 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 doesn’t need oil and its by-products, and if somehow it doesn’t 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.
• 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
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 country’s 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
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 country’s 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 of International Peace Research Institute, Oslo (PRIO) – 2006 analyzes the strategic implications of India and China’s 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
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 of stable, long-term growth of the economy. Similarly, a financially strong and globally competitive oil industry provides an enduring platform to strengthen energy security of the country. It is therefore important that oil companies should have the freedom to set prices based on competitive market conditions. The government needs to extend subsidy to the targeted consumers in such a manner which does not impinge on the freedom of oil companies to set prices in the market place.
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 country’s total energy consumption.
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
• 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 control by 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)
• 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
India is not among the major producers of crude oil, as it doesn’t have much oil reserves. That is why it generally depends on imports of crude oil from other countries. However, the production and its by - products in India has increased in the recent past due to exploration and findings of new oil reserves. India currently has an estimated quantity of 5.4 billion barrels of oil reserves out of which it produces around 0.8 million barrels per day. At this production level, the oil reserves in India would last for around 29 years.
The major oil reserves of the country are situated at
• Mumbai high (Mumbai)
• 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
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
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
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
Crude influences the economy in many ways. Not only it directly affect the manufacturing industry but also affects one’s 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 what’s in store for him next.
3.1 Facts and Figures.
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
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
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 global prices. • 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.
CHAPTER 4 FACTOR INFLUENCING CRUDE OIL PRICE IN INDIA
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,
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
CHAPTER 5 ROLE OF GOVERNMENT IN OIL SECTOR
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 country’s 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 India’s 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
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 country’s 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.
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.
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
Crude oil prices remained volatile during FY’04 and 1st quarter of FY’05 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 FY’04 had adverse impact on oil companies in India as end fuel prices were not reset to reflect 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
be borne by the OMCs. It is estimated that total subsidy burden on account of under pricing for FY’04 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%.
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
• 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 FY’04.
• 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 available as 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
CHAPTER 7 CRUDE OIL FUTURES
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 requirement and 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.
The volatility in the International Oil markets can be gauged by the fact that oil prices 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
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
counter-party risks as all transactions are cleared and guaranteed by MCX. It also offers individual investors with another trading instrument for them to capitalize on their views of the volatile crude oil prices caused by the political tension in the Middle East. Real Time Oil Prices The best bids and offers on MCX are continuously disseminated on a real - time basis through price vendors for the benefits of all market users. This gives market users a real-time price reference that is fair, equal and easily accessible. MCX also provides a daily settlement price. Wider Market Participation With counter - party risk addressed by the clearing and guarantee offered by MCX, there can be greater involvement by more participants. In addition to larger and more active oil companies, smaller companies, MCX individual members and individual investors would also be able to trade MCX Crude Futures. Flexible Transaction Size The relatively small contract size of 100 barrels allows oil market participants to hedge varying sizes of crude oil exposure effectively. Price variation Unlike previous years, which were under the APM and protected with Oil Pool account, now crude price is having a high co relation with the international
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
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 in the 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.
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
Table no. 7 : Central Excise and custom tariff
CUSTOMS Basic Additiona Additi Customs Duty l Customs onal Duty (CVD) Custo ms Duty
CENTRAL EXCISE Basic Special Additiona Cenvat Duty Additio nal Excise Duty Nil+Rs.2 500/MT as Cess+ Rs.50/ MT NCCD as l Excise Duty
NIL + Rs. 50/MT as NCCD
Rs.6.35/ltr Petrol 2.5% . SAD Petrol (branded) High Speed Diesel High Speed Diesel (branded) Domestic Nil Non LPG 5.0% Domestic Keros PDS Nil ene Non PDS 5.0% Aviation Turbine Fuel NonNil Nil 8.0% Nil 14.0% 8% Rs.2.00 /ltr. Rs.7.50/l tr 2.5% NIL Nil Rs.3.75/ Ltr Nil 8.0% Nil 14.0% 8% Rs.6/ltr Rs.2.00/ltr . Re.2.00/ltr . Re.2.00/ltr . + Rs.2.00 Rs.6.35/l tr Rs.6.00/ltr /ltr. Rs.6/ltr Rs.2.00/ltr .
5.0% Fertilizer ha Fertilizer Nil Bitumen & Asphalt 5.0%
14.0% Nil 14.0%
Table no. 8: Dealers commission on Petrol and Diesel
Effective date 1-Apr-04 21-Jun-05 1-Aug-05 1-Mar-07 16-May-07 23-May-08 27-Oct-09 7-Sep-10 1-Jul-11
Petrol 707.0 778.0 848.0 894.0 1024.0 1052.0 1125.0 1218.0 1499.0
Diesel 425.0 467.0 509.0 529.0 600.0 631.0 673.0 757.0 912.0
Table no. 9 : Distributor Commission on LPG
LPG 14.2 Kg. 5 Kg. 8.60 9.81 10.58 11.30 13.30
As on 01-April-04 1-Mar-07 4-Jun-08 30-Jun-09 1-Jul-11
16.71 19.05 20.54 21.94 25.83
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:
Sustainability of high growth with moderate inflation. Inclusive nature of growth, which means the “aam admi” should share the benefits of high economic growth.
Table no. 10 : Impact of oil prices
International Oil price per barrel ($) 50 60 70 80 140
Increase in International Oil Prices (%) 38.9 66.7 94.2 122.2 126.1
Extent of fall in manufacturing Sector growth (%) 2.1 9.7 16.9 24.5 29.7
Extent of fall in GDP growth (%) 0.4 1.9 3.4 4.9 7.3
Extent of increase in WPI (%) 1.5 3. 5.7 7.9 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. India’s dependence on oil imports, which is around 75% today, is expected to touch 90% in the next two decades. India’s 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.
• 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
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 India’s 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
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. 1.5 per liter for diesel. When compared with India’s 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 India’s 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 India’s 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
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
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), Hydrocracker, Coker unit, Lube Unit are the several things which crude goes through to become petrol or diesel.
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 couldn’t 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. India’s oil subsidies are 0.4 percent of India’s total budget in 2008.
CHAPTER 11 CHANGE IN PRICE OF CRUDE OIL
Figure no. 5 : Change in crude oil prices and its finished products
CHAPTER 12 PRICE DISCOVERY
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
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
• 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 of Full Range of Crude Oils. Use of Appropriate Marker to avoid Price Premiums. Availability of Refined product futures to provide for Crack Spread Hedging.
• Contracts to be made tailored to meet market Requirements.
Regulatory guidelines & Suitable Accounting Standards and Tax policies.
12.2 Indian Conditions
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-à-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 .
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:
12.3 The Issue Of Asian Risk Premium : Dubai Crude Being An Ineffective Marker
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
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.
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 and Dubai, 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.
• 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
a) Lessons form the experience from Japan’s 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 don’t 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.
v. Margin calculations to be rationalized , reflecting real time market risk.
b) Lessons from Singapore’s 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 government’s Hands-Off policy has really paid in developing a competitive market.
RECOMMENDATION A] Petrol
• 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 Two Wheelers (Petrol) Three Wheelers (Petrol) Cars (Petrol) Cars (Diesel) MPV (Diesel) Bus (Diesel) Heavy Trucks (Diesel) Light Trucks (Diesel)
Average Distance Covered annually (KM) 6300 (10000) 35000 (40000) 8000 (15000) 8000 (15000) 7800 (37000) 55000 (60000) 55000 (35000) 20000 (40000)
Fuel Efficiency (KM/Litre) 73.0 34.0 13.5 14.0 8.7 4.1 3.6 4.5
Litres/ Vehicle/ Year 86 1,029 593 571 897 13,415 15,278 4415
Monthly Fuel Cost at price on 1.1.10 in Delhi (Rs) 320 3835 2210 1566 2461 36802 41913 12112
• 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). Motorized vehicle 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.
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.
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. Agriculture’s 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,
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.
• 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
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
India’s 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
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.
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:
• • • •
Cost of buying finished product in the country Government excise and tax rates Government subsidies for fuel Currency fluctuations
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
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 no independent price discovery in India because the oil market is not free. fuel prices are largely decided by the central government. crude futures trading in Indian commodity exchanges does not help price discovery as the open market is not totally free
2. Who decides the fuel prices government / oil companies?
A: In India, oil prices are not market-driven; but determined by the government. it is called 'administrative price mechanism' (APM); of late it has been watered down.
3. Trading of crude oil in Indian commodity exchanges is really helping for the price discovery of these products ?.. Yes/ No WHY? A : All trading transactions in Indian commodity exchnages are speculative contracts and not hedge contracts. in other words, the purpose of futures trading is not served. no delivery of oil takes place through Indian bourses. my view is, there is no need to permit crude futures in India as it does not advance anyone's.
Journals & Research Papers : 1. Yoshiki Ogawa, Ph. D. , Proposals on Measures for Reducing Asian Premium of
Crude Oil-- Changes in Pricing, Unity among Consuming Countries and Preparation of Oil Market, IEEJ: November 2002. 2. TOCOM and the Big Bang by Bob H Takai General Manager, Commodity Business Dept, Sumitomo Corporation, The London Bullion Market Association, The Alchemist issue 33. 3. Government Of India, New Delhi – Report on A Viable and Sustainable System of Pricing of Petroleum Products: February 2010. 4. The International Energy Agency (IEA) - report PETROLEUM PRICES, TAXATION AND SUBSIDIES IN INDIA (2009) 5. International Energy Agency: Focus on Asia Paciﬁc report Petroleum product pricing in India
• http://www.tocom.or.jp/ • www.indianexpress.com
• www.nymex.com • http://www.ncdex.com/index.aspx • http://www.firstpost.com
http://economictimes.indiatimes.com/ http://indianeconomy.org http://indiabudget.nic.in/ http://mospi.nic.in/Mospi_New/site/home.aspx
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