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					         Industries Limited

Impact of High Oil Prices
Challenges in Petroleum Product Pricing

               Ashok Dhar
             August 24, 2006
Contents…


  Rise in International Oil Price
  India – Pricing Challenges
  Govt. Policy – Impact and the Way Forward
  Is there a better way for us?
  Response to High Oil Prices – International
   Experience (Developing Countries)
  Summing up and Recommendations




                                                 2
Rise in Crude Oil Prices
International Pricing Determinants

                  Geo Political                           Seasonal
                    Events                                 Factors

                                              Inventory
                                                                     Regional
   Speculation
                                                                      Supply
                                                                     Demand


 Energy                           Crude Oil
 Security                          Prices
                                                                Arbitrage
 Concern


Future Cost
of Discovery
      &                                                      Product
Development                                                   Prices
                Demand
               Growth and
                Logistics

                 Well Established System for Price Determination
                                                                                4
 What impacts Product Prices ?

                   Trading                            Geographical Dimensions


Over the Counter
 (OTC) Markets
 for Customized                               USA
   Swaps and                                                    Regional          Regional
     Options                   Market                           Dynamics         Interaction
                             Settlemen
  Organized                  t Prices at                       Demand Supply       Arbitrage
 Exchange for                              North West                             Opportunity
   Futures                     various      Europe
                                                                   Stocks
                                                                Geo Political    Demand Supply
   Contract                   locations                           Aspects
                                                                  Product
                             by Platts/                         Specification
                                                                Consumption
 Spot Market                    Argus                             Pattern
                                                               Seasonal Factor
   (Physical
   Delivery)                               Asia Pacific




                   Multiple factors at work for determining product prices
                                                                                                 5
Rise in Crude Oil Prices




     We are in an era of inevitable high Oil Prices in medium
                               term

                                                                6
Prices of Petroleum Products




        Product Prices broadly track crude price but
            correlations are not always strong.
                                                       7
Crude Price Outlook- Normal Pattern
        70
        65
        60            Oman / Dubai    IB   Brent     WTI                                                        Indian Basket
        55
        50
                                                                                                             Month      Landed
        45
        40
                                                                                                                         Cost
        35                                                                                                              Rs./KL
        30
        25                                                                                                   Jul-06      22,444
        20
        15                                                                                                   Aug-06      22,883
        10
         5                                                                                                   Sep-06      23,026
         -
                                                                                                             Oct-06      23,160
                          03-04                             04-05                         05-06
                                                                                                             Nov-06      23,322
   80
                                                                                                             Dec-06      23,322
   78                                                                                                        Jan-07      23,475
   76                                                                                                        Feb-07      23,475
   74                                                                                                        Mar-07      23,475
   72
   70
   68
   66                                          (Dubai+Oman)/2        Indian Basket         Brent      WTI
   64
             Jul-06     Aug-06       Sep-06        Oct-06   Nov-06   Dec-06      Jan-07    Feb-07   Mar-07
  Source: Platts quotes and Morgan Stanley Assessment July 18, 2006


                      Crude prices may perhaps harden beyond $100/Bbl
                                  of WTI if there are spikes
                                                                                                                             8
India – Pricing Challenges
     Calculated Ratio of Prices
     An indicator of Govt. Policy vis-à-vis other developing
     Countries
Most Recent Retail Price Ratio
Country                   Gasoline /Diesel   Gasoline/Kerosene   Diesel/Kerosene
                                                                                   Since Product Prices are broadly
Argentina                         1.3               1.3                1.0
                                                                                   comparable net of taxes, large
Bangladesh                        1.4               1.4                1.0
Chile                             1.4               1.4                1.0         deviations of calculated ratio from
China                             1.0                -                  -          unity reflect Taxation and Subsidy
Ghana                             1.1               1.3                1.2
                                                                                   policy of respective Govt.
Guatemala                         1.3               1.2                0.9
India                             1.4               4.9                3.5
Indonesia
Kenya
                                  1.0
                                  1.2
                                                     -
                                                    1.5
                                                                        -
                                                                       1.3
                                                                                      In no other country,
Malawi                            1.0               1.3                1.2             prices are as distorted as
Morocco                           1.4               1.4                1.0             in India
Nigeria                           0.9               1.3                1.5
Pakistan*                         1.5               1.6                1.1            Heavily Subsidized fuel
Philipines                        1.1               1.0                0.9
                                                                                       lead to criminal activities
Sri Lanka                         1.5               2.3                1.5
Thailand                          1.0               1.0                1.0             through illegal diversion
Tunisia                           1.5               2.1                1.4
Uganda                            1.1               1.2                1.1            Developing countries are
Vietnam                           1.4               1.4                1.0             adopting other means to
Zambia                            1.0               1.3                1.3             provide relief to Lower
* Notified ex-depot prices.
Source: WorldBank/ ESMAP Report                                                        Income Households.

          In India, the fact that 38% of PDS Kerosene is diverted to
                      non-PDS use shouldn’t be surprising.

                                                                                                                         10
Subsidy Delivery leads to temptation

SKO & LPG - Subsidies                                      60

   Price distortion leads to large scale adulteration ofRs/L   Inducement for Diversion / Misuse
    petrol and diesel with subsidized kerosene (38% 50
    of PDS SKO)
                                                           40
   Appx. 1 MMT of subsidized Domestic LPG is
    understood to be getting diverted to unauthorized                    8                           37
                                                           30
    application in transportation and commercial
    sector.                                                                      26
                                                           20

   Challenges
                                                           10
         Targeting Subsidy only to those who
          need it (BPL)
                                                           0
                                                                HSD    SKO       SKO       MS       LPG (D)
         Improving Administration of LPG and                          (Non     (PDS)
                                                                       PDS)
          Kerosene Subsidy




                                                                                                      11
 Macroeconomic Variables: A
 Comparison

                                                                    Oveall Fiscal Debt/GDP
Country               Vulnerability (%)      Terms of Trade
                                                                  Surplus/GDP (%)    (%)
Bangladesh                    -1.6                  86                               36.1    Vulnerability: The ratio
Brazil                        -1.3                  128                  3.8         46.6    of Value of Net Oil
China                         -1.4                  95                  -2.8         13.6    Import to GDP –
Ghana                         -4.4                  99                  -2.8        104.4
                                                                                             Vulnerability of Economy
India                         -2.9                  94                  -9.3         19.2
Indonesia                       0                   93                  -1.7         56.6    to an Oil Shock
Malaysia                       2.3                  102                 -5.3         47.2
Pakistan                      -3.6                  84                               43.6    Terms of Trade: Changes
Philippines                   -4.4                                      -4.7         80.7
                                                                                             in ratio of Export Price
SriLanka                      -4.6                  109                 -8.3         56.1
                                                                                             Index to Import Price
Thailand                      -4.8                  90                   0.3         36.1
                                                                                             Index
Source: World Bank 2006e, EIA 2005a, authors calculations, Macroeconmic variables for 2003




       We are less resilient for facing oil shock as compared to China
            and it can affect our economic growth aspirations.

                                                                                                                   12
    Government Policy
Impact and the Way Forward
Year 2002
Deregulation aimed to attract Investment

   APM – APM didn’t help in generating enough investment
    and investment were necessary
   Sundararajan Committee and R Group recommended
    liberalization of the Industry and giving up APM
   ETG spelt out road-map for deregulation and Nov’ 97
    notification outlined the roadmap
   March 2002 – Govt. announced the conditions for
    marketing rights for MS and HSD
   March 2002 – Resolution announced dismantling of APM
    from April 1, 2002 and Prices of MS & HSD to be market
    determined and SKO & LPG subject to flat subsidy

A well planned approach aimed at liberalizing the Industry and
                   bringing-in investment

                                                                 14
Year 2004
Private Players made huge Investment

  RIL invested over Rs. 4,000 crores in the retail
   network and backend infrastructure like
   Terminals , IT etc.

  RIL dealers have invested more than Rs. 1,500
   crores in setting up about 860 ROs. Most dealers
   have invested their life’s savings in setting up
   the RO.

  The transporters have invested over Rs. 500
   crores in TTs to supply fuel to these ROs.
  Customers appreciated Product and Service quality at Reliance
      that helped the company gain 15% market share with
             only 4% share in Industry retail network
                                                                  15
Year 2004 – 2005
The Industry Observed a Paradigm Shift

                              Fleet services
                          Efficient fleet operations
                            Emergency services
                              Vehicle tracking
                                MIS services



                                                        Drivers Loyalty
Quality and Quantity           Reliance’s                    Food
                               Uniqueness              Showers and Toilets
Through technology                                      Secured Parking



                            Superior customer
                               experience
                             Courteous service
                       Convenient payment mechanisms


   Q&Q through use of technology enhanced customer satisfaction.

                                                                             16
   Quantity & Quality Assurance at Reliance




                                              Company owned and             Accurate preset
Replenishment         Comprehensive
                                               managed inventory              premix deliveries to
 system linked to       sealing mechanism
                                              Central monitoring of bulk     2/3 wheelers
 stock monitoring at   Vehicle (tanker)
                                               stocks through automatic      Electronic calibration
 RO                     monitoring and
                                               tank gauging at the ROs        of metering
Product (tanker)       tracking system
                                              Online monitoring and          assembly of
 filling by bulk
                                               reconciliation of stocks       dispensing unit for
 meters and
                                               and sales                      accurate delivery
 automated process
                                              Remote diagnostics of key
                                               components in dispensing
                                               units

     Technology based process make Q&Q a reality from end to end in an integrated format

                                                                                               17
Rewards & Recognitions
Reliance Petroleum Retail

 Innovative Retail Concept of the year – Franchise
  India Awards 2005

 Franchisor of the year – Franchise India Awards 2005

 Innovation & Technology in Franchising – (The Reid
  & Taylor Awards for Retail Excellence ) at The India
  Retail Summit 2005

 Retail Concept of the year for Reliance Truck Stops –
  Retail Awards at India Retail Forum 2005

 Golden Peacock Award in the category of Eco –
  Innovation for Truck-Stop as a concept – WEF


                                                          18
Year 2006
Options to Private Company

   RSP was increased to maintain a differential of Rs 2.50 per
                  Litre in both MS and HSD

                                     Market Share dropped to <2% from 15%
           Continue Marketing &      Company Investment of over 4000 Crores
            Continue Absorbing
                                      and Dealer Investment between 1.5 - 2
                  Losses
                                      Crores per RO : Idling

                                     Transporter (3745 Trucks) Investment of Rs
                                      524 Crores Idling

                                     55,000 Jobs at Risk

                                     Competition will die
              Reduce Volume
              Increase Prices        Consumer expectation on world class Q & Q
                                      will die a premature death




                                                                                   19
The Industry : Standing at Crucial
Crossroad


    Oil Industry may stagnate without Investments in
     Exploration, Refining and other Downstream sector
    Investment will depend on Government Policy
    It is not enough that the Government puts in place
     reasonable and attractive Policy for Investment but shall
     also Implement as published
    If implementation is off-policy in any sector, it will affect
     Investments in all sectors.


         Investor Confidence is critically linked to
     Government Policy and its implementation in letter
                        and spirit
                                                                     20
Oil Bonds and Upstream Assistance for
PSUs
                                                                     GoI Estimates
                                                                               MS    HSD     SKO     LPG     TOTAL
                               UNDER RECOVERIES
                                 Pre Revision                                 8390   37940 19403      7779   73512
                                 Less Price Increase                 Rs Crs   3107    6289                    9396
                                 Less Impact Shift to Trade Parity            1189    5248                    6437
                               Gross Under recovery                           4094   26403 19403      7779   57679
                                                                      TKL/
                               Annual Volume                          TMT     12078 45734 11926       9844   79581
                               Net Under Recovery                    Rs/SU    3.39    5.77   16.27     7.9    7.25
            How PSUs are covered fully
                                                Rs Crores

Total Under recovery Post Revision              57679                Since no subsidy is given to
PDS SK Limited to BPL with increased allocation 3000                  private sector, Private Oil
                                                28000
Oil Bonds
                                                                      Companies are left with an
Upstream Assistance                             24000
Discounts from Refineries
            ?                                   2500
                                                                     Under Recovery of Rs3.39/L
Total Coverage                                  57500                on MS and Rs5.77/L on HSD
Uncovered Under recovery                         179

A non level playing field has been created between Public and Private
sector
                                                                                                                     21
Under Recovery Estimates


Product      Volume                                             Under Recovery                                TOTAL     Per SU
             (TKLs/TMTs) Till June'06          Jul'06 Aug'06 Sep'06 Oct'06 Nov'06 Dec'06 Jan'07 Feb'07 Mar'07
MS                 12,805       1,906            788    802    790    775    757    757    763    763    763      8,864     6,922
HSD                51,136       8,759          3,650 3,738 3,798 3,879 3,979 3,979 4,173 4,173 4,173             44,301     8,663
SKO (BPL)          10,178       4,522          1,992 2,078 1,581 1,604 1,626 1,626 1,669 1,669 1,669             20,036   19,686
SKO(Non BPL)        1,748                                                                                           -         -
LPG                 9,844       2,211          1,394 1,812 1,799 1,784 1,767 1,767 1,772 1,772 1,772             17,853   18,137
TOTAL                          17,398          7,825 8,430 7,969 8,042 8,130 8,130 8,377 8,377 8,377             91,053


Provisions (Rs. Crs) :           Upstream     24,000
                                 Bonds        28,000
                                 Budget *      2,400 Adjusted for SKO (Non BPL)
                                 Refineries    2,500
Additional Required (Rs Crs) :                34,153




                          More Government support is unavoidable.


                                                                                                                                    22
Is there a better way ?
 Under-recoveries for OMCs

               Retail selling Price and TPP in Rs per liter (Aug 2006)
                                   TPP*             TPP*          Under-recovery     Under-recovery
Petrol        Current Price
                              (1st Fortnight)   (2nd Fortnight)    (1st fortnight)   (2nd fortnight)

Delhi            46.85            53.16             53.56              6.31               6.71
Kolkata          51.07            57.65             58.06              6.58               6.99
Mumbai           52.71            59.44             59.87              6.73               7.16
Chennai          51.83            58.67             59.10              6.84               7.27

                                   TPP*             TPP*          Under-recovery     Under-recovery
Diesel        Current Price
                              (1st Fortnight)   (2nd Fortnight)    (1st fortnight)   (2nd fortnight)

Delhi            32.25            40.50             40.54              8.25               8.29
Kolkata          34.96            43.53             43.58              8.57               8.62
Mumbai           39.68            49.42             49.47              9.74               9.79
Chennai          35.51            44.56             44.60              9.05               9.09
* Estimated



    Under-recoveries too high for bridging by improvement in efficiency.
   Centrality of pricing issue for Energy Security needs to be recognised.

                                                                                                   24
Managing Volatility



    Crude Price        < $40        $40 - $50           > $50
    (Per Barrel)
    Customs           Increase        Stable       Reduction

    Excise            Increase        Stable       Reduction

    Sales Tax          Stable       Reduction      Reduction

    Consumer          Reduction       Stable           Increase
    Price




                Flexible taxing to manage volatility

                                                                  25
Reduction in Excise Duty



  Product                                                  Current                 Suggested #
                                                   Ad Valorem     Specific *   Ad Valorem   Specific *
                                                                  (Rs./KL)                  (Rs./KL)
  MS                                                8.16%     13260               NIL           7140
  HSD                                               8.16%      3315               NIL           3060
  Estimated Revenue (Rs. Crs)                            46043                          31538
  Shortfall (Rs. Crs)                                                                   14505
  Estimated Under Recoveries (Rs. Crs)                      53164                       38659
  Savings in Under Recoveries (Rs. Crs)                                                 14505
  * Including Road Cess on MS HSD
  # Figures based on assumed implementation of suggestion from 1st Aug'06




 Better alternate to Oil Bonds could be “Duty Rationalization”


                                                                                                         26
Can we reduce Sales tax as well ?


 Product                                                    Current                    Suggested #
                                                                  Specific                     Specific
                                                   Ad Valorem     (Rs./KL)       Ad Valorem    (Rs./KL)
 MS                                                    27.02%    251.21              20%           NIL
 HSD                                                   21.41%    168.52              12%           NIL
 Estimated Revenue (Rs. Crs)                               45940                           34825
 Shortfall (Rs. Crs)                                                                       11116
 Estimated Under Recoveries (Rs. Crs)                        53164                         42887
 Savings in Under Recoveries (Rs. Crs)                                                     10277
 * Estimated Revenue in 04/05 , a normal year was Rs.31196 Crs on MS & HSD for States.
 # Figures based on assumed implementation of suggestion from 1st Aug'06
                  At suggested Rates, the STATES GET A BETTER REVENUE


                                                                            Combination of Duty and
  Uniform Sales Tax / VAT in States is
                                                                             Tax Rationalization can
   FAIR TO PUBLIC
                                                                                reduce unrecovered
  Reduction in Rates shares central
                                                                                 Under Recoveries
   burden with states.

                                                                                                          27
    Response to High Oil Prices
International Experience (Developing Countries)
Policy Responses; 10 Key questions




   Source: World Bank ESMAP Report

   Even Net Oil Exporters have responded with mandatory
        Conservation Measures and Cash Transfer.
                                                          29
Pass through to Consumers




   Source: World Bank ESMAP Report
 For India, the coefficients during the same period are 1.25 for Gasoline and 0.66 for
                                         Diesel.

               World over, esp. Oil importers have passed on
                       Oil Price hikes to consumers

                                                                                         30
Pass-Through Co-efficients for
Gasoline




   Only 30% of the countries in the sample passed through
        less than 75% of international price increase.
                                                            31
Pass-Through Co-efficients for Diesel




   Like Gasoline, there is similar trend on Pass-Through co-
  efficient for diesel. However, the average pass-through co-
                               efficient
                    is relatively less for diesel.
                                                                32
Ghana: A Case Study
 The Country imports both crude and product and
  exports some products
 Product price were subsidised by Govt. until 2005   Ghana Economic Indicators
  and prices were increased irregularly.                       (2004)
                                                      Population= 20.5 million
 Govt. faced popular opposition to price hikes
                                                      Per Capita Income= $2,100
 In May 2005, Govt. established Independent          Primarily an Agriculture
  Agency (NPA) representing Public and Private           Economy
  Sectors                                             GDP Growth rate =3.3%
                                                        (2003)
 Ghana linked prices to International market based
                                                      Debt/GDP = 104.4% (2003)
  on NPA recommendations.
                                                      Oil Production = 15 to 20% of
 NPA bases its pricing recommendations on world                      its
                                                          consumption
  market and on established domestic margin for
  distribution
     In May 2006, NPA departed from custom of setting uniform
       prices and today Retailers in Ghana post different prices

                                                                                 33
How did Ghana do it ?
 In 2004 Govt. launched PSIA (Poverty and Social
  Impact Assessment) for fuel
 A steering committee was established
  representing Ministries, Oil Company, and
  Academia. PSIA was completed in a year.
 By the time Govt. announced 50% price increase
  in February 2005, it had findings of the PSIA,
  which helped them argue their case:
   – Who were benefiting most from price subsidies    (Better-
     off members of the society more than the poor)
   – Who were winners and who were losers with the new
     policy

   PSIA allowed Govt. to asses affected members
          and indicate mitigation measures

                                                                 34
Ghana – Mitigation Measures

  Immediate elimination of fees at Govt. run
   Primary School and Junior Secondary Schools
  A program to improve Public Transport
  Public Relation campaign with Minister of
   Finance making Radio Broadcast
    – About the price increase and need for them
    – At the same time announcing various mitigation measures

  Series of interview with Govt. officials as well as
   trade union officials
      Transparency helped Society understand
    situation and positively respond to mitigation
                      measures
                                                                35
 Indonesia: A Case Study
 Indonesia has a history of subsidising certain
  oil products
 The continuation of this policy had vastly              Indonesia Economic Indicators
  increased total cost to the Govt.                                (2004)

                                                         Population= 217 million
 Eventually, Govt. took-up to the challenge –           Per Capita Income= $3,100
  large fuel price increase – and                        GDP Growth rate = 3.5% (2003)
  simultaneously addressed potential adverse
                                                         Debt/GDP = 56.6% (2003)
  effects on the poor
                                                         One of the richest country in
   – Reallocating funds to targeted cash transfer –         Natural Resources
      Direct grants to generate labour intensive jobs,   Oil Production = Became Net
      improve infrastructure                                 Oil         Importer in
                                                             2004
   – Pro-poor programs in Education, Health and
     Rural poverty reduction – Waiving school fees,
      scholarship to poor students, Health Insurance
      cover etc.
      The price adjustment in 2005, resulted in overall price
     adjustment of 149%, 161% and 186% for Gasoline, Diesel
                    and Kerosene respectively
                                                                                   36
Summing up…
The Fact – Regulatory Overview

       Published Policy                        Ground Realities

Market Determined Pricing for MS & HSD    Controlling the Prices (Full Control on
(No Intervention in Pricing)               Pricing)

   Compensation only for LPG & SKO           Compensating PSUs for all Products

Transparent Under recovery Compensation   Non Transparent Selective Compensation
Package                                    Package

   Level Playing Field for all Players       Killing Competition




      Manipulation of market price and non transparent way of
       compensating select players for under-recovery were
                  never a part of published policy.

                      Is the Govt. going back on de-regulation?

                                                                                      38
Recommendations ..
 Let us have a simple, transparent system of pricing which is
  based on following postulates
   – Induce consumers to use petroleum products efficiently and cleanly
   – Subsidise a consumer, rather than than the product. Target subsidies only
     to the deserving beneficiary segments
   – Specify specific duties or levies that are transparent and simple, not ad-
     volarem
   – Target for One India – One Market – One rate of tax – for petroleum
     products and look for other sources of revenue generation
   – Create awareness in country on the issue to achieve full pass-through

 Let market forces determine prices
   – Appoint Regulator soonest to ensure fair play, competition and optimal
     utilisation of Industry Infrastructure

 Let us have no discrimination between different companies on
  ownership or any other criteria.
   – Treat PSUs and Private players on par for oil subsidy to create a level
     playing field.

 Let us learn from other developing Countries
   – Study in greater depth steps being taken by countries like Ghana,
     China, Thailand, Malaysia, Indonesia, Philippines etc. and pick-up
     successful interventions.                                          39
Thank you

				
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