Implication for Refining Margin

In the refining of crude petroleum a variety of products arise and the refinery margins are usually related to cracked margins. In fact a barrel of crude on distillation gives both lighter and heavier fractions. The lighter components consisting of LPG, MS, ATF, kerosene, HSD, etc. command higher margins and are high value products with prices that are generally higher than that of the crude oil. The heavier components - such as furnace oil, bitumen and coke- commands lower margin and sell at prices lower than that of crude. Moreover a part of the crude oil is consumed to produce the heat needed in the refining process and this ranges from 6 to 8 per cent for modern refineries43, usually termed as Refinery Boiler Loss (RBL). Thus, in order for the refining operation to be viable, the selling prices of the higher value       

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Ultra-modern refineries consume more as RBL as their complexity which enables them to work with very difficult (very heavy and sour) crude oils also involve more processing.

refinery fractions, that is, the light and middle distillates must cover (a) the direct cost of crude; (b) the cost of the RBL; (c) the negative contribution from the lower-than–crude oil values that will be realized on the sale of the heavy ends and coke; (d) the operating and capital servicing costs of the refinery.

A refinery usually tries to optimize its capacity and boost its margins by procuring heavy crude (with high sulphur content) available at cheaper prices to produce more remunerative light and middle distillates. However, Indian PSU refineries usually have higher yields of heavier ends, whereas the private sector with modern refineries has the capacity to maximize lighter ends and middle distillates. Consequently the refining margins of the private sector refinery are far superior to that of public sector refineries (GoI, 2005).

Gross Refinery Margin (GRM) can be defined as the difference between the costs of raw material (majorly crude) and weighted average prices of petroleum products. Given the fact that GRM of the refining business depends on the weighted average prices of petroleum products, it is contingent upon the pricing mechanism of the petroleum products that is being followed by the Indian refineries. In the APM era refining margins were administered by the government on the basis of fixed return on capital employed (i.e. on a cost plus basis, as explained before) which in the post-APM era used to be decided initially on an import parity basis and currently on trade-parity basis for petrol and diesel. However, it ought to be reiterated here that in computing the notional import or trade parity prices the actual cost of exploration and refining within the country or factors like inter-refinery differences in respect of crude oil, production pattern, size, complexities of refineries etc. are not taken into account. Thus the derived GRM under the import parity / trade parity regime is dissociated from the aforesaid factors which ideally should have been reflected in GRM in order to distinguish between the GRM of an efficient and inefficient refinery.

Furthermore, given the fact that every refinery is unique in terms of its ability to process various crude forms and generate products, the production levels can be different. Thus it becomes very difficult to determine a benchmark GRM using the weighted average

production of various refineries44. If a refinery could produce more high-value products or refine various forms of crude it could post GRMs above the benchmark GRMs.

The factors that generally lead to an increase in gross refining margins are:-

¾ Crude selection (proper crude mix),

¾ Import of crude in larger parcels to improve economies of scale in respect of freight, landing charges etc.,

¾ Higher spreads between crude and product prices which are further dependent on differential in international prices of both crude and products, duties like customs duty on crude and the differential between customs duty on crude and products and other taxes (like entry taxes) that are imposed on crude etc.

¾ Enhanced production of value added products and

¾ Reduction of cost

Of all the above factors, the higher spread between the crude and petroleum product prices in the international market has contributed mostly towards increasing domestic refinery margins in the post-APM era especially since 2004-05.

The product–crude spread is usually considered as the difference between a unit measure (barrel or KL or tonne) of crude oil (delivered at a specific location) and the wholesale selling price (refinery gate price) at the same location. In most international markets like USA (New York Harbour and Gulf Coast), North West Europe (Amsterdam-Rotterdam- Antwerp or ARA) and Singaporethe spreads for both petrol and diesel (refinery gate price) over crude oil acquisition cost in 2002-03 has been observed as hovering around 25 per cent. In 2003-04 the spread changed to over 30 per cent for petrol and little less than 25 per cent for diesel. Fig. 1.9 below shows the average annual spread between the refinery gate prices of petrol and diesel and the composite crude acquisition cost for the US45.

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Usually, Singapore is considered as a benchmark, and the Singapore margin calculation considers Dubai crude oil as an input and assumes a product mix of approximately 32% gasoline (petrol), 19% of jet fuel and kerosene, 16% of diesel/gasoil, 23% fuel oil, 3% LPG and 7% bitumen/naptha.   

45 _{The coefficient of variation (CV) between the market prices of gasoline, HSD and kerosene reported at the}

various centres in the USA (New York Harbour and Gulf Coast), North West Europe (Amsterdam- Rotterdam-Antwerp or ARA) and Singapore has been observed as fairly small and the trend has been towards smaller variation, most pronounced in the case of diesel and also in gasoline (petrol) and jet fuel.

Fig.1.9: Spread between Composite Crude and Gasoline (Petrol) and Composite Crude and Diesel (HSD) for US New York Harbour (in per cent)

Data Source: PPAC

As per import parity system, the pricing of the products was calculated in the country on the basis of the international prices of the products from April 2002 onwards. This building up of the import-parity prices on a notional basis, as explained before, ultimately led to ballooning of the prices of the products in the domestic market.

In order to estimate the average product margins for Indian Refiners-cum-OMCs in the period immediately after dismantling of APM, the Report of the High Powered Committee on Financial position of oil companies (GoI, 2008) assumed a 2.5 per cent margin on trading sales, and a total marketing and distribution margin at the rate of 5 per cent in 2002-03 and 2003-04. Thus the report estimated that the average product margins over the purchase cost of crude for these years amounted to 50 to 60 per cent for IOC, between 40 and 50 per cent for BPCL and about 25 to 40 per cent for HPCL. The report underscored on the possibility that the financial position of IOC and BPCL for these years might have derived partly from consideration other than efficient operations. However from 2004-05 onwards the crude oil        

In other words, there is a considerable degree of co-movement in the market prices reported at these centres. (GoI, 2008).

prices rose steeply and the corresponding increase in the retail selling prices were also restrained by the government. As a result, the margins of these three companies fell sharply to 20 per cent and below, in 2006-07 and continued to decline further in 2007-08.