India's fuel retailing gets a crude
shock By Indrajit Basu
KOLKATA - Had he not been the chief
operating officer of a gasoline-marketing company
today, Raj Verma might be a happy man. And why
not? After all, more than 700 dealers are pressing
him hard to supply his company's products and open
more outlets.
Still, Verma is harried. His
company, Essar Oil, a local oil-marketing company
that sources gasoline and diesel from other
refineries and sells them through its mostly
franchisee-owned gas stations, is currently losing
8 and 12 US cents respectively on
every liter of gasoline and
diesel sold. Yet he has to resume supplies to
about 300 filling stations and commission 400 more
because owners of these gas stations are now
threatening to desert Essar Oil, if it doesn't
comply.
These dealers, according to Verma,
have invested in acquiring gas stations at prime
locations across India, and without oil supplies
from Essar Oil they could shift loyalties to
competitors. So, besides supplying at a loss,
Varma would also have to pay a compensation at
17.5% on the investments these dealers have made
on the gas stations, as well as the regular dealer
commission on per liter of fuel sold.
But
Raj Verma can at least draw consolation from the
fact that he is not the only one suffering, though
being a pure marketing company without a refinery
just yet, his company has been hit the hardest.
Reliance Industries, India's biggest producer of
petrochemicals and petroleum products, with more
than 1,260 gas stations or retail outlets in the
country, is facing similar problems. So is Royal
Dutch Shell, which entered the fuel-retailing
arena in India about three years back and now has
15 gas stations.
With global oil prices
hitting record highs almost every other week and
the Indian government tightly controlling street
prices of gasoline and diesel by keeping them much
lower than international prices, the
fuel-retailing plans of all the privately owned
petroleum companies are in quandary, as all
oil-marketing companies - state-owned ones
included - are struggling to keep their retail
operations afloat.
Take Reliance, which
reported on Thursday that despite more than 10 %
growth in net profits in the quarter ending in
June, its net profit margins have dropped 16% in
the quarter from the same period last year.
"Despite higher selling prices, our
operating profits were affected due to higher raw
material costs," a Reliance statement said. "The
period witnessed huge pressure on the retail
marketing business as a result of the
unprecedented rise in crude oil prices and
inadequate increase in the selling prices of
gasoline and diesel."
Reliance may be
moaning about a reduction in profit margin, but it
is in less trouble than others thanks to the fact
that it has "one of the most efficient" refining
capacities. The scorching crude-oil prices have
made Essar Oil's operations unsustainable. Unable
to bear the losses due to soaring crude prices,
Essar Oil was forced not only to cut supplies of
gasoline and diesel to about 200 franchisee-owned
gas stations, but had to close down about 300 of
them as well. And indeed, the Indian
fuel-retailing story that began with a bang three
years back now looks like a damp squib against the
background of the current global oil crisis.
In a landmark decision in April 2002,
India removed the widely criticized Administered
Pricing Mechanism (APM) that allowed only four
state-owned companies - Indian Oil Corp (IOC),
Hindustan Petroleum Corp (HP), Bharat Petroleum
Corp (BP) and IBP Co - to retail gasoline and
diesel on a cost plus fixed return (of 12% after
tax) basis. The removal of this mechanism also
allowed private oil companies to open their own
filling stations and retail gasoline and diesel.
This was obviously greeted with
enthusiasm. Three private companies led by Essar
and two state-owned oil companies, which were not
allowed to retail fuel under the APM regime,
promptly acquired licenses to set up more than
11,000 retail outlets across the country. However,
spiking international crude-oil prices, which
began in 2003, suddenly nipped these oil
companies' fuel marketing ambitions in its bud.
The rising prices not only forced the Indian
government to hurriedly re-exercise partial
control of at least the state-owned oil companies,
it also took the fizz out of the initial
enthusiasm of the new players. Their ambitious
fuel retailing plans gave way to stagnation as the
new players ended up opening only about 1,900
outlets, representing about 17% of the permitted
market.
Reliance, for instance, has so far
opened 1,266 outlets versus its marketing rights
for over 5,800, and Essar Oil, which had acquired
rights for 2,000 outlets, opened 518 initially but
closed down about 300 soon after. The achievement
is even more dismal for Shell India that had
obtained marketing rights for 2,000 outlets but
has opened just fifteen, while Oil and Natural Gas
Corp (ONGC) Ltd, the country's largest oil company
(primarily in explorations and refining), which
was given 1,100 outlet licenses, has opened only
one. The other state-owned oil company, Mangalore
Refineries and Petrochemicals Ltd, subsidiary of
ONGC, which is supposed to share its parent retail
responsibilities, hasn't opened even one.
So what has gone wrong? Clearly it's the
government's unwillingness to raise domestic
selling prices at par with the international
prices. Although the April 2002 liberalization
allowed the state-owned oil companies to mark
their price to the market, the government brought
back its right to fix retail prices of gasoline,
diesel, kerosene and liquid petroleum or cooking
gas (LPG), since these were "politically
sensitive". Oil-marketing companies say that at
the current crude-oil prices of $74 per barrel,
the retail prices should be anything between 8 and
10 cents higher for a liter of gasoline, and about
12-15 cents higher for a liter of diesel
(depending on which part of India they are sold
in).
Of course the private oil companies
still have the freedom to set their own retail
prices, and both Essar and Reliance have, in fact,
marked their gasoline and diesel prices higher (at
5.4 cents - Rs2.5 - and 15.3 cents - Rs7 - per
liter respectively) than street prices. But says
Reliance, "The higher retail price compared with
PSU [state-owned oil company gas station] selling
prices has resulted in a drastic drop in market
share for the company at its retail outlets. Even
with this differential in price, the company is
incurring substantial under-recoveries in retail
marketing."
"My daily sales have come down
to a trickle," said the manager of a
Reliance-owned retail outlet. "Perhaps the Plaza
is doing better business selling dosas."
Almost all Reliance (and Essar) gas stations mimic
the international gas-retailing format and come
with a restaurant called "A1 Plaza" that sells
Indian food, dosa included.
For
that matter the four state-owned oil marketing
companies (HP, BP, IO, and IBP) too are suffering.
At $70 per barrel of crude, these companies were
losing $35 million each day on under-recoveries -
a euphemism for losses the oil industry suffers
when the selling price does not recover the costs.
And this is despite the 9.2% hike in gasoline
prices and 6.6% in diesel prices announced by the
government in early June. Industry sources say
these four companies could end the financial year
2006-07 with a revenue loss of $16 billion and
under-recoveries of more than $22 billion.
Still, the private oil companies say that
the state-owned oil companies are better off.
That's because whenever international prices rise
higher than domestic prices, the government
subsidizes the state-owned oil companies' losses
by issuing tradable oil bonds, which carry
attractive rates of interest for five to seven
years and for the oil companies are almost like
liquid cash. The oil companies can either sell
these bonds or use them as collateral to raise
cash.
For 2006-07, the government has
already announced oil bonds worth $6 billion
(compared with $2.5 billion last year) and has
also directed the state-owned upstream oil
companies ONGC, GAIL Ltd and Oil India Ltd to bear
some of the losses of the four state-owned oil
marketing companies by offering $6.08 billion
($3.04 billion in 2005-06) as discounts on refined
oil and other products sold to them.
This
form of subsidizing, says Reliance, hits the
privately owned oil companies below the belt,
since it "favors only the state-owned oil
marketing companies in a partisan and
non-transparent manner". It adds that subsidizing
selectively also reverses the April 2002
liberalization, since "the freedom [given to
private oil companies] to increase prices is not a
solution to the problem in a commodity market
where the government subsidizes selectively and
forces those who are not subsidized to close down
businesses irrespective of whether they choose to
exercise the freedom or not".
Which is why
Reliance and Essar have joined hands to demand oil
bonds from the government. While Reliance has
demanded bonds worth $130 million, Essar wants at
least $43 million this year.
"Had the
private sector companies not been operating retail
outlets, the volumes sold by private companies
would have been sold by state-owned oil marketing
companies, and the government would have given
them an additional subsidy by way of oil bonds,"
Essar said in its letter to the Oil Ministry. "As
such there would be no additional outgo from the
government if the losses incurred by the private
companies are compensated."
Nevertheless,
there could be light at the end of the tunnel,
even if the tunnel seems to be getting longer
every day. According to Alexander's Oil and Gas
Connections, a Germany-based oil-industry
publication, since "a lot of capital is leaving
the market; it now seems that the upward-driving
forces are lessening. On the supply side, several
major projects in Africa and Central Asia are
likely to come onstream, which would also balance
the market and take away some pressure from the
market."
Says a marketing official from
Reliance: "Oil retailing may not still be as bleak
as it looks right now." And if Alexander's
projections come true, crude-oil prices could
settle down in the long term, perhaps bringing the
grin back on Raj Verma's face.
Indrajit Basu is a Kolkata-based
journalist.
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