Indian Oil Refinery Scenario

1 January 2017

Approximately 72 million barrels per day. (7. 33 barrels make one tonne. For petro products manufactured by them, oil refineries in India are paid the ‘import parity price’, the international price plus the insurance and freight cost plus the customs duty. Thus, higher the customs duty, higher will be the gross refining margin. If the customs duty is cut, say, to 10 per cent, the domestic company would reduce its price from 15 per cent above the landed cost to 10 per cent above the import parity price. In case it does not do so, the customer, that is the marketing company, will import the product. India does not import petrol, but a cut in customs duty on petrol reduces the domestic price of petrol.

Higher duties on products are imposed to encourage the growth of the refining industry. In this case, the intention is to encourage the domestic refining industry, by ‘‘protecting’’ it. Today crude has a customs duty of 10 per cent, but the customs duty on petro products is 15 per cent.

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The value addition in the refinery business is around 10 per cent; the duty differential of 5 per cent means that the ERP is very roughly 50 per cent. When the customs duty was 20 per cent, before the recent cuts, the effective rate of protection was even higher.

Cutting duties only on crude oil will not reduce the domestic price of petroleum products. It will only increase the profit margin of domestic refineries. The first step should be to eliminate rate dispersion by bringing down the duties on petro products. When the customs duty on crude oil and petroleum products is equal, then this anomalous profitability of Indian refineries would be removed. Duties on oil and petro products still involves penalising Indian consumers owing to the presence of tariffs. Hence, for the consumer, the best thing is zero customs duties.

In this case, Indian refineries would have to compete with international refineries. Refineries in India are already major exporters of petro products. This shows that they already have the engineering capability to compete with the best refineries of the world. However, if after decades of protection, refineries in India are still not efficient, there is no reason why consumers should bear the burden of their inefficiency. Nearly 50 per cent of the price of petrol that we pay at the petrol pump goes to the Government as excise and sales tax. For diesel, nearly one-third goes as tax.

The discrepancy is because the excise on petrol is 63 per cent of import parity price (23 per cent + Rs 7. 50 per litre) and on diesel is 16 per cent (14 per cent + Rs 1. 50 per litre). No. The Government will not lose any customs revenue as India does not import petrol or diesel. The custom duties unfairly protects the refinery and penalises the Indian consumer, who has to pay prices higher than in the rest of the world. Government Policy Petroleum exploration & production was controlled by the Government-owned National Oil Companies (NOCs), ONGC and OIL, in pursuance of the Industrial Policy Resolution, 1954.

In the early 70s, they supplied nearly 70% of the domestic requirement. However, by the end of the 80s, they had reached the stage of diminishing returns. Oil production had begun to decline whereas there was a steady increase in consumption and today the two NOCs are able to meet only about 35% of the domestic requirement. This was further compounded by the resource crunch in the beginning of the 90s. The Government had no money (FE) to give to the NOCs for the development of some of the then newly discovered fields.

While some of these fields could be developed by ONGC (Gandhar, Neelam, Bombay High, Lakwa, Heera, Geleki etc. ), for others there was no money available for indigenously developing the fields. The problem had elements such as the administered oil price, non-availability of appropriate technology, logistics etc. Petroleum Sector Reforms, 1990 The Government launched the Petroleum Sector Reforms (PSR) in 1990. Till then, three rounds of exploration bidding had been gone through with no success in finding new oil/gas deposits by the foreign companies who only were allowed to bid.

Under the PSR, the Fourth, Fifth, Sixth, Seventh and Eighth Rounds of exploration bidding were announced between 1991 and 1994. For the first time Indian companies with or without previous experience in E&P activities were permitted to bid starting with the Fourth Round. The Government then announced the Joint Venture Exploration Program in 1995. The exploration blocks were in those areas for which the Petroleum Exploration License was with the NOCs and they were required to have a 25% to 40% Participating Interest from day one. Foreign Companies in Exploration in India

Foreign companies entered the Indian E&P scene since early fifties (Indo Stanvac Project- A Joint Venture between Government of India and Standard Vacuum oil Company for West Bengal onland in early fifties, Carlsbons Natomas for Bengal offshore in early seventies, Assamerc for Cauvery offshore and Reading and bates for Kutch offshore also in early seventies and later since the first round in 1980; Shell for Kerala offshore and Chevronn- Texaco in Krishna – Godavery Offshore). This was certainly not as much as elsewhere in the world. Exploration and Production: )

To begin with, the government in early nineties has changed the much awaited legal status of the Oil and Natural Gas Commission (ONGC) by converting it into a Corporation there by giving it more autonomy. Oil and Natural Gas Corporation Ltd (ONGCL) – a limited company governed by the Indian Company Acts was formed. Earlier, ONGC was governed by the Acts of the Parliament. ii) As the government decided in favor of more involvement of private sector in exploration and production, there was a need to establish an independent regulatory body that could effectively supervise the activities of all the companies – private and public.

Thus the Directorate General of Hydrocarbon (DGH) was set up in April 1993. Since then, the privatisation process of the exploration and production activities have been accelerated. iii) The most noteworthy policy shift was the decision of the government to involve private and foreign companies in the development of already discovered fields. In the first offer of such fields in August 1992,contracts for 5 medium sized and 13 small- sized fields have been awarded. Enron Oil and Gas Company, Reliance Industries Ltd, Command Petroleum, Videocon Petroleum Ltd, Ravva Oil Pte Ltd were few such major foreign and Indian private companies .

ONGCL and OIL’s share in those JVs were limited to 40% only. The estimated oil and gas production from these fields were 360 billion barrels and 50 billion cubic meters respectively. The most promising fields of Panna, Mukta and Mid & South Tapti which had been successfully explored earlier by ONGC were offered to Enron -Reliance consortium without reimbursing the past exploration expenses to ONGC. More over the government agreed to purchase the produced crude from the consortium at the international price plus a premium of $4 per barrel as the sulphur content was low.

In the second offer for the development of 8 medium and 33 small size fields, negotiations for the award of contracts are at an advanced stage. iv) From 1991 to 1996, the government had held five rounds (fourth, fifth, sixth, seventh and eighths) of bidding for exploration acreages offering as many as 126 blocks, ranging in sizes from a few hundred square kilometers to over 50,000 sq kilometers. 11 contracts have been awarded. Some of the important companies which have been either awarded contracts or participated in the exploration round were: Shell, Occidental, Amoco, Enron).

However,all these efforts could not improve the crude and gas reserve of India. In 1990-91, the crude oil reserve was 739 MMT which has declined to 658 MMT in 1999-2000. The corresponding natural gas reserve figures were 686 bcm and 628 bcm respectively. In that period, the crude production also declined from 33. 02 MMT to 31. 95 MMT and in 1999-2000, India had to import 44. 99 MMT crude. The above figures clearly indicates that the government policy of involving the private parties- both Indian and foreign offering liberal terms did not help the upstream petroleum sector.

On the contrary, reserves and production have drastically fallen in the post liberalisation period. Some of the incentives announced by the government were: •No custom duty on imports required for petroleum operations. •No minimum expenditure commitment during the exploration period. •No mandatory state participation. •No carried interest by National Oil Companies •Freedom to sell crude crude oil and natural gas in domestic market at market related prices.

Biddable cost recovery limit upto 100% •No cess on crude oil production •Royalty payment: 12. 5% for onland areas,10% for offshore and 5% for deep water areas. Liberal depreciation provisions •Seven years tax holidays from the commencement of production. Refining In the eighties, the government decided to invite private companies in the refining sector. The private company Reliance Petroleum Ltd (RPL ) has become the second largest player in oil refining sector with 27 MMTPA state of the art refinery at Jamnagar, Gujarat. Apart from approving new refineries in the private and joint venture(involving Indian and foreign companies) there has not been any major policy change in the establishment of new refineries in the nineties.

However, from June 1998, the refining sector has been delicensed. Moreover, private and joint sector refineries have been permitted to import crude oil freely without import license for actual use in their own refineries. This will have adverse effect on the operating cost of public sector refineries should international crude price falls below the domestic crude price. Marketing In India the market of refinery is oligopoly and there is price rigidity In the nineties, major policies as under in the marketing of petroleum products with far reaching implications have been announced by the government.

To attract private investment in exploration, the government has announced that any company investing nearly US$400 million (Rs20 billion) in exploration and production or other specified avenue, would be eligible for marketing rights for petroleum products in India. This will allow the international oil majors to enter into the lucrative marketing sector. ii) In September 1997,the government has decided to dismantle Administrative Pricing Mechanism (APM) in phased manner. By April, 2002 it will be fully dismantalled and prices of petroleum products will be determined on the basis of import parity system.

The existing system of petroleum pricing which is also called APM (natural gas was kept out of this pricing mechanism) has its roots in the early seventies when Shipping Corporation of India (SCI) took loan from the World Bank to purchase oil carriers. The World Bank then recommended a ‘cost plus’ pricing formula to SCI for freight calculation. The same principle in the name of ‘retention concept’ was later(1976) introduced to crude and petroleum products pricing system. Accordingly, the price of indigenous crude was based on operating cost plus 15% post tax return on capital employed.

And oil refineries and marketing companies calculated the price of their products on the basis of operating cost plus 12% post tax on net worth. Conclusion In India the demand of energy is rising by 20% specially in automobile industrial and farm sector so refining capacity is necessary although the country has excess capacity so government should try to boost the exports by taking corrective and prevent steps through the public and private sector participation giving maximum fiscal and budgetary support.

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