Impact of High Oil Prices

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• Impact of High Oil Prices
• Challenges in Petroleum Product Pricing

Ashok Dhar August 24, 2006
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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

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• Rise in Crude Oil Prices

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International Pricing Determinants
Well Established System for Price Determination
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What impacts Product Prices ?
Multiple factors at work for determining product
prices
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Rise in Crude Oil Prices
We are in an era of inevitable high Oil Prices in
medium term
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Prices of Petroleum Products
Product Prices broadly track crude price but
correlations are not always strong.
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Crude Price Outlook- Normal Pattern
Source Platts quotes and Morgan Stanley
Assessment July 18, 2006
Crude prices may perhaps harden beyond 100/Bbl
of WTI if there are spikes
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• India Pricing Challenges

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Calculated Ratio of Prices An indicator of Govt.
Policy vis-à-vis other developing Countries
Since Product Prices are broadly comparable net
of taxes, large deviations of calculated ratio
from unity reflect Taxation and Subsidy policy of
respective Govt.

• In no other country, prices are as distorted as
  in India
• Heavily Subsidized fuel lead to criminal
  activities through illegal diversion
• Developing countries are adopting other means to
  provide relief to Lower Income Households.

In India, the fact that 38 of PDS Kerosene is
diverted to non-PDS use shouldnt be surprising.
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Subsidy Delivery leads to temptation

• SKO LPG - Subsidies
• Price distortion leads to large scale
  adulteration of petrol and diesel with subsidized
  kerosene (38 of PDS SKO)
• Appx. 1 MMT of subsidized Domestic LPG is
  understood to be getting diverted to unauthorized
  application in transportation and commercial
  sector.
• Challenges
• Targeting Subsidy only to those who need it (BPL)
• Improving Administration of LPG and Kerosene
  Subsidy

Inducement for Diversion / Misuse
Rs/L
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Macroeconomic Variables A Comparison
Vulnerability The ratio of Value of Net Oil
Import to GDP Vulnerability of Economy to an
Oil Shock Terms of Trade Changes in ratio of
Export Price Index to Import Price Index
We are less resilient for facing oil shock as
compared to China and it can affect our economic
growth aspirations.
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• Government Policy
• Impact and the Way Forward

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Year 2002 Deregulation aimed to attract
Investment

• APM APM didnt 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
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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 lifes 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
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Year 2004 2005 The Industry Observed a Paradigm
Shift
Fleet services Efficient fleet operations Emergenc
y services Vehicle tracking MIS services
Quality and Quantity Through technology
Drivers Loyalty Food Showers and Toilets Secured
Parking
Reliances Uniqueness
Superior customer experience Courteous
service Convenient payment mechanisms
QQ through use of technology enhanced customer
satisfaction.
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Quantity Quality Assurance at Reliance

• Company owned and managed inventory
• Central monitoring of bulk stocks through
  automatic tank gauging at the ROs
• Online monitoring and reconciliation of stocks
  and sales
• Remote diagnostics of key components in
  dispensing units

• Accurate preset premix deliveries to 2/3 wheelers
• Electronic calibration of metering assembly of
  dispensing unit for accurate delivery

• Replenishment system linked to stock monitoring
  at RO
• Product (tanker) filling by bulk meters and
  automated process

• Comprehensive sealing mechanism
• Vehicle (tanker) monitoring and tracking system

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

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Year 2006Options to Private Company
RSP was increased to maintain a differential of
Rs 2.50 per Litre in both MS and HSD
Continue Marketing Continue Absorbing Losses

• Market Share dropped to lt2 from 15
• Company Investment of over 4000 Crores and Dealer
  Investment between 1.5 - 2 Crores per RO
  Idling
• Transporter (3745 Trucks) Investment of Rs 524
  Crores Idling
• 55,000 Jobs at Risk
• Competition will die
• Consumer expectation on world class Q Q will
  die a premature death

Reduce Volume Increase Prices
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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
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Oil Bonds and Upstream Assistance for PSUs
Since no subsidy is given to private sector,
Private Oil Companies are left with an Under
Recovery of Rs3.39/L on MS and Rs5.77/L on HSD
?
A non level playing field has been created
between Public and Private sector
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Under Recovery Estimates
More Government support is unavoidable.
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Under-recoveries for OMCs
Under-recoveries too high for bridging by
improvement in efficiency. Centrality of pricing
issue for Energy Security needs to be recognised.
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Managing Volatility
Flexible taxing to manage volatility
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Reduction in Excise Duty
Better alternate to Oil Bonds could be Duty
Rationalization
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Can we reduce Sales tax as well ?
Combination of Duty and Tax Rationalization can
reduce unrecovered Under Recoveries

• Uniform Sales Tax / VAT in States is FAIR TO
  PUBLIC
• Reduction in Rates shares central burden with
  states.

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• Response to High Oil Prices
• International Experience (Developing Countries)

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Policy Responses 10 Key questions
Source World Bank ESMAP Report
Even Net Oil Exporters have responded with
mandatory Conservation Measures and Cash
Transfer.
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Pass through to Consumers
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
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Pass-Through Co-efficients for Gasoline
Only 30 of the countries in the sample passed
through less than 75 of international price
increase.
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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.
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Ghana A Case Study

• The Country imports both crude and product and
  exports some products
• Product price were subsidised by Govt. until 2005
  and prices were increased irregularly.
• Govt. faced popular opposition to price hikes
• In May 2005, Govt. established Independent Agency
  (NPA) representing Public and Private Sectors
• Ghana linked prices to International market based
  on NPA recommendations.
• NPA bases its pricing recommendations on world
  market and on established domestic margin for
  distribution

Ghana Economic Indicators (2004)
Population 20.5 million Per Capita Income
2,100 Primarily an Agriculture Economy GDP
Growth rate 3.3 (2003) Debt/GDP 104.4
(2003) Oil Production 15 to 20 of
its consumption
In May 2006, NPA departed from custom of setting
uniform prices and today Retailers in Ghana post
different prices
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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
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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
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Indonesia A Case Study

• Indonesia has a history of subsidising certain
  oil products
• The continuation of this policy had vastly
  increased total cost to the Govt.
• Eventually, Govt. took-up to the challenge
  large fuel price increase and simultaneously
  addressed potential adverse effects on the poor
• Reallocating funds to targeted cash transfer
  Direct grants to generate labour intensive jobs,
  improve infrastructure
• Pro-poor programs in Education, Health and Rural
  poverty reduction Waiving school fees,
  scholarship to poor students, Health Insurance
  cover etc.

Indonesia Economic Indicators (2004)
Population 217 million Per Capita Income
3,100 GDP Growth rate 3.5 (2003) Debt/GDP
56.6 (2003) One of the richest country in
Natural Resources Oil Production Became Net
Oil Importer in 2004
The price adjustment in 2005, resulted in overall
price adjustment of 149, 161 and 186 for
Gasoline, Diesel and Kerosene respectively
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• Summing up

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The Fact Regulatory Overview
Ground Realities
Published Policy

• Controlling the Prices (Full Control on
  Pricing)
• Compensating PSUs for all Products
• Non Transparent Selective Compensation Package
• Killing Competition

• Market Determined Pricing for MS HSD (No
  Intervention in Pricing)
• Compensation only for LPG SKO
• Transparent Under recovery Compensation Package
• Level Playing Field for all Players

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?
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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.

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• Thank you