Oil companies: Sliding on subsidies

Raghuvir Srinivasan

THE red ink splashed across the balance-sheets of the four major oil companies — Indian Oil, BPCL, HPCL and IBP — in the first quarter may have dried but the underlying causes for the losses have certainly not gone away. So, are these companies headed for an encore in the second quarter?

At best, these companies may manage to post a minor profit with the help of some imaginative accounting; at worst, they may end up posting losses yet again, albeit a smaller quantum. But, make no mistake, the bad times are far from over for these companies.

It all boils down to this single question: what does a company do when its input cost rises by more than 50 per cent in a year but is able to pass on only a small portion of that to its customers? It begins to lose money. And that is exactly what is happening to these four companies, which are forced to absorb big losses in marketing margins, because of government policy.

Killing "under-recoveries"

The story is well worn. The government is exercising strict control over these companies, preventing them from setting market-related prices for their main products — petrol, diesel, cooking gas and kerosene — and asking them to share more than 90 per cent of the subsidy burden on the latter two products.

Added to this is the so called "under-recovery" on petrol and diesel, which is nothing but the difference between the selling price of the two products and the price paid to the refineries for the same.

Due to the non-revision of retail prices of petrol and diesel at periodic intervals in tune with the market, the oil companies have been incurring a loss as they have been forced to sell at a price lower than what they pay the refineries.

For instance, Indian Oil suffered a loss of Rs 1,188 crore on this account in 2004-05 and a further Rs 1,362 crore in the first quarter of 2005-06, ended June 30.

Just consider these numbers. The average price of the Indian basket of crude oil (which is the relevant comparison and not Brent or WTI, which sell at a premium) in the first three weeks of this month was $59.91 a barrel compared to $39.15 exactly a year ago — a rise of 53 per cent. And how much have the retail prices of petrol and diesel increased in the same period? The retail selling price of petrol was hiked by 18 per cent, and that of diesel 25 per cent.

Refineries are better off

The refineries have not been affected by this asymmetry as much as the marketing companies. For one, they are paid for their output on landed cost, which is based on the prevailing international price and, second, this includes a 10 per cent duty on petrol and diesel, which straightaway beefs up their margins.

Therefore, the stand-alone refining companies — Chennai Petroleum, Kochi Refineries, Bongaigaon Refinery and Petrochemicals and Mangalore Refinery and Petrochemicals — have been spared the troubles of the refining and marketing companies. This shows in their relative performance in the last four quarters (see infographic).

This is also why Reliance Industries, which operates the country's largest refinery with a capacity of 31 million tonnes, has been unaffected.

With global oil prices rising sharply, the refining margin (the difference between the selling price of the refined products such as petrol and diesel and the cost of crude oil) has been very healthy, at $5-10 per barrel for all these refineries.

Again, the stand-alone refining companies, as indeed Reliance Industries, have been spared from sharing the subsidy burden on cooking gas and kerosene, which was shared among the three refining and marketing companies and ONGC, Gail and Oil India.

However, as part of the policy changes of the last fortnight, henceforth, these companies will also be sharing a part of the subsidy burden. As per the new framework decided, Reliance Industries will offer up to Rs 750 crore as discounts on the two products to the marketing companies.

This may come as marginal relief to the refining and marketing companies — Indian Oil, BPCL and HPCL — which are reeling under the twin impact of under-recoveries on petrol and diesel and the huge subsidy on cooking gas and kerosene.

The oft-repeated argument against these three companies is that they enjoy superior refining margins and can, hence, afford to take a loss in marketing margins. The truth is that these companies sell more than what they produce by procuring products from the standalone refineries and Reliance Industries.

Therefore, they stand to lose on the marketing margins on the quantum of products that they procure from others. They pay the landed cost for these products to the refineries but sell them at the artificially fixed lower prices in the market.

For instance, almost 27 per cent of Indian Oil's product sales in 2004-05 was from products procured from refineries other than its own. The corresponding figures for HPCL and BPCL are 25 per cent and 43 per cent respectively. IBP, which procures 100 per cent of its products from other refineries, is naturally the biggest loser among all these companies.

In other words, the gains in refining margins are not enough to compensate for the loss in marketing margins.

Losses fuelled by subsidy

The second factor weighing down the financial performance of these companies is the subsidy on cooking gas and diesel. The numbers are revealing. In fiscal 2004-05, the total subsidy on the two products was Rs 21,400 crore.

Of this, the government's budgetary contribution was just Rs 3,550 crore, or 17 per cent, with the remaining 83 per cent coming from the oil companies. Indian Oil and ONGC, as the largest of the lot, had to bear the brunt of this.

The projections for the current fiscal are scary. The subsidy bill is expected to shoot up to Rs 40,000 crore, of which the government share will remain at Rs 3,640 crore, or about 10 per cent. The burden of this subsidy is sure to weigh heavily on the balance sheets of all the oil companies except Gail, whose share is relatively minor.

ONGC will bear about Rs 12,000 crore, roughly equivalent to the gains it would make in terms of higher crude oil prices. Therefore, the net loss for the company may not be substantial.

However, Indian Oil, BPCL, HPCL and IBP are likely to suffer despite the burden being shared by ONGC and the standalone refining companies.

The issue of oil bonds is unlikely to be of much help in boosting their cash flows, which have begun to sag in the last four months. Indian Oil, for example, was forced to borrow Rs 1,000 crore from the bond market last fortnight to tide over its cash-flow problems.

The scene at the other refining and marketing companies are not too good, either. The bonds may at best result in a reclassification of assets from receivables to investments.

The increasing borrowings will push up financing costs for the companies, which are already talking of postponing their major investments for better times.

Though these threats are largely nothing more than that, the fact is that if the current liquidity crunch continues, these companies may indeed be forced to go slow on their investments, which is not good news for the country's energy security.