“STUDY OF CRUDE OIL PRICES FLUCTUATION IN INDIA”

INTRODUCTION TO INDIAN OIL SECTOR

1.                  India maintains price controls on four “sensitive” petroleum products – petrol, diesel, liquefied petroleum gas (LPG), and kerosene – to insulate consumers against high global Crude oil prices. India’s government owned Oil Marketing Companies are tasked by the Government of India to sell these products in retail markets at a centrally determined realized sales price. Upward revisions to prices in response to higher global crude prices are rare.

2.    As international crude prices began structural appreciation from 2004, OMCs began recording significant “under-recoveries” on the sale of sensitive petroleum products. Under recoveries is a notional measure representing the difference between the trade-parity refinery-gate cost of refined product paid by OMCs and their managed sale price? In FY 2008-09, OMCs under-recoveries amounted to over USD 25 billion.

3.  The Government of India has been forced to issue hundreds of billions of Indian rupees to OMC counteract mass under-recoveries since 2005 in order to maintain the solvency of these key companies. This has increasingly occurred via the extension of off-budget “oil bonds” – debt securities issued to OMCs to be traded by these companies for liquid cash, or to be used as collateral for borrowing in financial markets. The Government of India issued close to USD 20 billion in oil bond debt to OMCs in FY 2008-09.

4. The fiscal impact of under-recoveries resulting from managed product prices has become acute. Off-budget debt issuance, in particular oil bond issuance, has led to a fiscal overflowing India. India’s government deficit across levels of government and including off-budget components more than doubled in nominal terms from 5.7% of GDP in FY 2007-08 to11.4% in FY 2008-09. This has greatly reduced the flexibility of the (GoI) in responding to the current global recession, threatened to compromise the (GoI)’s ability to borrow cost effectively in international capital markets and sparked fears of “twin deficits” stagnation.

5.                  Two key objectives motivate the (GoI)’s policy in India’s downstream petroleum sector:

 (a)   Ensuring India’s growing refined product demand is met at affordable prices over time;

    

 (b)   Establishing India as a major global refined product exporter. Aside from its    fiscal implications, India’s current petroleum product pricing regime has implications for the achievement of these goals, and for the emergence of timely refining investments that are crucial to their achievement.

6.  To begin with, current pricing practices have made public-sector OMCs reliant on the (GoI) for working capital from period-to-period. Despite this, this paper finds that OMCs have invested strongly in refinery capacity in recent years. Between 2007 and 2012 – the years of India’s 11th Five Year Plan – OMCs will have added over 6,00,000 barrels per day (b/d) in Greenfield refining capacity and close to 300 000(b/d) in Brownfield capacity. This wills more than match India’s rapidly growing refined product demand in this period. The OMC sector is therefore defined by heavy-handed regulation and lackluster commercial performance, yet robust investment, capacity addition and growth. In all that follows, US dollar conversions are based on the average dollar-rupee exchange rate for fiscal

7.  Private-sector refinery investment in India, too, is shown to be robust in both the recent past and in the near future. From the commissioning of Reliance Industry Limited’s (RIL) 2 Jamnagar II refinery in late 2008 to the scheduled commissioning of Essar Oil’s Vadinar II refinery in 2012, private-sector refiners will have added around 1.2 million barrels per day (b/d) of new refining capacity. This has been driven by: (a) private-sector refiners’ scope to profitably supply domestic Indian markets by selling wholesale to OMCs, thus avoiding exposure to managed prices; and (b) India’s significant comparative advantages as a base for export-oriented refining operations.

8.    As a combined result of public-sector and private-sector refinery investments in the recent past, India will emerge by 2012 as Asia’s largest refined product exporter, surpassing Singapore. India will remain one of Asia’s two largest refined product exporters for the foreseeable future. India’s sudden emergence as a global petroleum producing hub is likely to have far-reaching implications for regional product markets, increasing the depth of product flows and strengthening supply chains, especially for high-end industrial product and clean transport fuels. The establishment of India’s large-scale export-oriented refining sector marks the acceleration of a fundamental shift in the configuration of global refining in which mature economies increasingly look to production hubs in Asia and the Middle East to supply incremental refined product demand.

9.   While the (GoI)’s downstream policies are likely to achieve their ambitious objectives in the medium term, they have done so at a tremendous fiscal cost. There is an urgent need to reduce the fiscal burden of the(GoI)’s system of unofficial petroleum product subsidies; to increasingly base OMC investment on market drivers and retained earnings rather than Government dictate; and to foster petroleum product conservation and substitution through clear price signals in product markets. The (GoI) must therefore increasingly move towards market-based petroleum pricing reform, while at the same time protecting access to energy markets for more vulnerable Indian consumers. Initially, this will require a concerted combination of regulated pricing reform and targeted subsidies.

THE GLOBAL SCENARIO

Globally, the oil & gas sector is dominated by certain large private companies who have a presence in almost all segments of the oil & gas value chain. Historically, oil price has been the single most important challenge facing the global oil industry. The problem is all the more acute as the large private companies account for only a small share of world oil production even as oil prices remain unpredictable and prone to wide fluctuations. Given this backdrop, global oil majors are now increasingly benchmarking their production costs against the oil production costs of the OPEC (Organization of Petroleum Exporting Countries), and increasingly relying on technological innovations and other cost cutting measures to lower their own production costs. The other factors influencing their decisions are the likely fall in oil prices after March 2000, rising demand for gas and lighter petroleum products, and the volatile and unpredictable nature of refining margins.

THE INDIAN SCENARIO

Unlike their global counterparts, Indian oil & gas companies have so far been operating in specific segments of the value chain. Oil & gas exploration, crude oil refining, distribution and marketing of petroleum products, and natural gas distribution are the key sub-sectors of the Indian oil & gas sector. The total sales turnover of this sector as a whole was around Rs. 1,500 billion as on March 31, 1999. The Indian oil & gas sector has historically been a regulated sector, dominated by Government undertakings. The regulation took the form of the Administered Pricing Mechanism (APM) under which the returns on investment were guaranteed. But now, with the APM being dismantled in phases and private players gaining a presence in the Indian oil& gas sector, the existing public sector oil companies are getting exposed to market forces and competition.

THE INDIAN UPSTREAM SECTOR

For the upstream players (the crude oil producers), the linkage to international crude oil prices implies volatility in earnings. While a rise in international crude oil prices would translate into a positive contribution to the bottom-line, a decline in the international prices, on the other hand, would exert pressure on the margins of all upstream companies. The national oil companies would, however, is protected from the downside risk by the floor price fixed by the government. But if the floor price is removed and the international oil prices drop to levels lower than the cost of production, even the national oil companies would require government intervention to protect their bottom-line. What aggravates the risk further is the fact that declining oil production and stagnating reserves dictate that the upstream companies venture into exploration areas that have high-risk-high-return profile (like deep water blocks). And this has implications for future exploration & production (E&P) costs. Given the emerging scenario, expects the strategies of the upstream players to focus on: use of better recovery techniques; employment of cost cutting measures; entry into high-risk-high-return areas (with the assumption that oil prices will not fall below the cost of production); integration into downstream areas; partnering; venturing into other geographical regions; and, undertaking organizational restructuring.

THE INDIAN DOWNSTREAM SECTOR

The phased dismantling of the APM has exposed the Indian downstream players (refiners and marketers of petroleum products) to market forces. The refining margins of the Indian refineries are now linked to the international refining margins. A fluctuation in the international prices of crude oil/ product translates into a variation in the domestic margins (although they are, to a large extent, protected by the positive net duty protection). In the first 18 months of decontrol (fiscal year 1999 and first half of fiscal year 2000), the profitability of Indian refineries has increased (and is expected to increase further) as their margins have increased following higher duty protection and linkage of crude and product prices with international prices. However, on the flipside, the expected surplus in the domestic market may limit this margin expansion. The other factors influencing the profitability of Indian refineries in the deregulated scenario would be refinery configuration, operating costs, and refinery location. The ownership of marketing and distribution infrastructure would be of strategic importance and would enhance profitability as the marketing sector is decontrolled. While the profitability of the integrated players would be higher and more resilient to economic troughs, the pure refining companies would find it difficult to sustain profitability in a decontrolled scenario. Accordingly, the pure refining and marketing companies are expected to be merged with the oil majors. A full decontrol of the marketing sector is likely to lead to severe competition among the various players in the industry, and greater focus on branding and product differentiation. Given the changes taking place, expects the strategies of downstream players to focus on: strengthening import infrastructure; enhancing scale of operations; upgrading processing facilities; implementing environmental projects; Strengthening marketing and distribution infrastructure and promoting brands; entering into strategic alliances; venturing into other areas of the energy value chain for optimizing the risk-return profile; and restructuring the organization.

THE INDIAN GAS SUB-SECTOR

The share of natural gas in India's energy mix has increased more than three times since the early1980s. Energy efficiency, multiplicity of applications, and environment neutrality are the key factors that are likely to propel further rise in demand for gas in India. The increase in demand could come both from the existing uses of natural gas and from newer applications. A rising demand for gas has implications on the supply level. An increased thrust on liquefied natural gas imports would signal positive developments on the supply front. Also expects the decontrol of the oil sector to enable the existing oil companies to pursue gas E&P activities more actively. The Gas Authority of India Limited, with a monopoly in natural gas distribution, is likely to benefit from the expected rise in natural gas supplies. Besides, its exposure to price risks would be minimal because of the fixed nature of natural gas transportation tariffs. Likely Strategic Initiatives Response to the phased deregulation, the strategic initiatives of the various players in the energy value chain would focus on the following factors. Product mix. This will have to be in line with market demand. Technology would play a major role in influencing the product mix. Strategic initiatives would also impact product mix. Cost competitiveness. Technological advancements and scale of operations would have an impact on operating costs. Infrastructure/Logistics. The ownership of infrastructure for sourcing crude oil and the logistics for distributing finished products would have a considerable impact on operating costs. Integration into different elements of the value chain would be imperative for bringing synergetic benefits, reducing volatility in earnings, and enhancing value addition. Brand building, pricing, and packaging. These would be used as tools to deliver greater value to customers.

WHAT DOES PETROLEUM MEAN?

Petroleum is a liquid that is found underground. Sometimes we call it oil. Oil can be as thick and black as tar or as thin as water. Petroleum has a lot of energy. We can turn it into different fuels-like gasoline, kerosene, and heating oil. Most plastics and inks are made from petroleum, too. People have burn oil for a long time. Long ago, they didn’t dig for it. They gathered that seeped from under the ground into ponds. It floated on the water.

PETROLEUM IS A FOSSIL FUEL:

Long before the dinosaurs, oceans covered most of the earth. They were filled with tiny sea animals and plants. As the plants and animals died they sank to the ocean floor. Sand and sediment covered them and turn into sedimentary rock. Millions of years passed. The weight of the rock and heat from the earth turned them into petroleum. Petroleum is called a fossil fuel because it was made from the remains of plants and animals. The energy in petroleum came from the energy in the plants and animals. That energy came from the sun.

PETROLEUM IS NON-RENEWABLE

The petroleum we use today was made millions of years ago. It took millions of years to form. We can’t make more in a short time. That’s why we call petroleum non-renewable. We import more than half the oil we use from other countries.

WE DRILL OIL WELLS

Petroleum is buried underground in tiny pockets in rocks. We drill oil wells in to the rocks to pump out the oil. A few wells are more than two miles deep. A lot of oil is under the oceans along our shores. Oil rigs that can float are used to reach this oil. After the oil is pumped to the surface, it is send to refineries. At the refineries, it is separated into different types of oil and made into fuels. Most of the oil is made into gasoline. The oil is moved from one place to another through pipelines and by ships and trucks.