EPP would impact GRMs by $2.80/bbl: IOC

The Kirit Parikh committee would look at the needs of all stakeholders before committing to the new mechanism of fixing oil product prices. Parikh, heading the committee looking at merits of Export Price Parity, told CNBC-TV 18 that when the market is competitive and there are enough players and consumers, trade parity price is the logical way to go.

In order to bring down the deficit by nearly Rs 15,000 crore, the finance ministry yesterday decided to change the pricing policy for petrol and diesel from "trade parity" to "export parity". The move is likely to reduce the selling price of fuels and impact the profitability of the already ailing PSU oil marketing companies. Speaking to CNBC-TV 18, PK Goyal, director finance of IOC said India imports 80 percent of crude requirements and EPP would impact gross refining margins (GRMs) by $2.8/bbl. He said diesel underrecovery has gone up to Rs 5 per litre and it is too early to say oil marketing companies have the freedom to increase diesel prices. Sudhir Vasudev of ONGC, who is not too happy with the move, said the company is working at subsidy contribution of Rs 12,000 crore in Q1. He expects a pro-rata cut in subsidy sharing In FY14. Below is the verbatim transcript of his interview to CNBC-TV18 Q: There have been enough furore that this export parity price (EPP) issue has raised since yesterday. You will be overseeing the committee that will look into the rationale for it. Where do you think the line of reason lies? Are you going to look into the merits of EPP or are you leaning towards that 80:20 kind of formula that people have been talking about? Parikh: We will have to look at all the different stake holders, their concerns and so on. The committee has not yet met. The committee will meet and look at it. On the theoretical side, of course one wants trade parity price which would prevent in a competitive set up. But of course our oil sector is not in a competitive set up. It has got a legacy of many political decisions and so on. So, one has to factor all these different considerations into accounts before we can decide - what is the policy which we think would be in the best interest of the country. It is not just the finance ministry or the ministry of petroleum and chemicals or oil market companies or the consumers. We have to look at the interest of all the people concerned. Q: What is your personal line of thinking at this point? We will not take it as the final decision of the committee of course but do you think economically speaking the case for export parity is stronger than the trade parity which exists now? Parikh: I don't think one should just hang on to the export. We are talking about trade parity not in 80-20 sense but in a competitive market what would prevail. Suppose you are in a market which is free, there are many producers and consumers and that you have a product which you are largely exporting. Then your opportunity cost of that product is what you can earn from export. Therefore you should charge your domestic consumer export price. On the other hand if the product is being imported then your opportunity cost is the import price. The consumers also if somebody tries to buy at a higher price, they can import and the import price should prevail. So in that kind of a situation it would be either the export price or import price if you are largely an exporter or importer. If you are a self sufficient person then the price would be somewhere in between. So that is the kind of logic that one would apply in mimicking the price of a competitive market. Whenever you are controlling any price or administering it you try to get to a level which would prevail in a competitive set up. However, of course we do not have a competitive setup. I was informed that people have set up refineries in places for public sector, for government’s political reasons. Therefore they cannot compete with refineries of other kinds. So one might have to factor these considerations into account in deciding what should be the price or what should be the mechanism by which we can compensate these companies who have had the legacy of political decisions and have to work in a competitive setup. Q: What are your thoughts and your submission to the finance ministry in terms of export parity price? It decided to knock out virtually all the profits of all oil marketing companies put together if implemented? Goyal: Our main point of view is that India is importing roughly 80 percent of the crude from Middle East, Nigeria and other countries. If we implement the free on board (FOB) prices, it will affect the gross refinery margins. For IOC, it is roughly USD 2.8. It will affect the gross refinery margins because FOB price does not include freight element, ocean loss, Letter of Credit (L/C) charges, war phases which is being incurred by oil marketing companies for importing crude. So, that is the biggest drawback if we implement the FOB prices. Most of the refineries are landlocked refinery. It is not on the port. So that also adds to the cost to the oil marketing companies. _PAGEBREAK_ Q: The argument in favour of it seems to be that a large part of this differential is courtesy what is happening with diesel. Now that you are seeing much more relief in terms of diesel pricing the EPP impact could actually come down significantly going into FY14. Would you say there is merit to that argument and having got more leeway now in pricing diesel you could actually absorb the impact if EPP is put into practice? Goyal: No, government has appointed the committee. It is too early to say what would be the final conclusion. We will review this aspect and based on the committee recommendation the necessary action will be taken. Q: What happens to FY14 diesel under recoveries assuming that you have the freedom you have had so far in terms of pricing it, what then would become the total EPP impact that companies such as yours, the OMCs would face? Goyal: It is too early to say there will be no under recovery on diesel because as on today it is Rs 3.73 on diesel and the last fortnight the prices of diesel has gone up. If you see the last one week the under recovery has gone to Rs 5. So it is too early to say that we have a freedom to increase the prices on monthly basis. However if we increase the prices between Rs 0.4-0.5 it will take another 8-9 months and we don't know what will be the scenario in the international market for diesel prices. Q: You have made your representation to the oil ministry because come June IOC will be looking to raise money from the market and if this issue is not resolved by the committee till then, it will be a significant overhang? Goyal: As on today the ministry has taken a decision that all the aspect for 2013-14 will be based on the committee recommendation. So, there will be no problem in raising money from the international market. Q: Do you see adoption happening in FY14 one way or the other? How soon can you discuss and recommend a final call to the government? Parikh: We have promised to give the report within three months time and we should be able to do that. Once we do that then it is up to the government to decide what to do. I cannot say this is what our recommendation would be. One has to listen to people and understand their arguments and then decide what the right way of doing it is. However I am quite sure we will give the report within three months time. Q: Part of the argument towards moving to this EPP model could also be seeing the complete freeing up of diesel pricing. Would you also look into that aspect of things? You have made suggestions in the past and some of it has been taken on board. Parikh: If it is completely freed then this question of export or import parity price doesn’t arise. The companies will sell it in the domestic market. If other players come into the market and sell it at the export parity price then that price would prevail. So a comparative setup would take care of everything. Then you don't have to worry about how to set the price, what should it be and so on. Hopefully, there will be an opportunity also for the government to go to a completely free set up of price determination. I think it will be in the best interest of OMCs and for the government as its burden will be removed and the OMCs can be act as real competitive free economic agents. Q: You must be happy with the formula which was put out on Wednesday; the fact that it appears Rs 60,000 crore will be the upstream burden. If that happens what would Oil and Natural Gas Corporation (ONGC) need to pay as its share of the subsidy burden? What would therefore the result in realisation per barrel be? Vasudeva: How can we be happy? On Wednesday, the formula has been unveiled and with Rs 161,029 crore subsidy, the government has agreed to pay Rs 1 lakh crore and balance Rs 60,000 crore has to be paid by the E&P companies. ONGC’s burden would be something around Rs 50,000 crore which is about Rs 6,000 crore more than what we paid last year. In the interim the cess also has increased by Rs 2000 per tonne which is another Rs 4000-5000 crore on our bottom-line. _PAGEBREAK_ Q: The hope is since the percentage share has not gone up dramatically that this year once the overall under recovery comes down to around Rs 1 lakh crore, may be you will not need to pay Rs 50,000 crore this year? Vasudeva: The formula is yet to be told to us but so far we have worked out at a rate of USD 56 per barrel of production which has been prevalent for the first nine months. With that the burden, comes to about Rs 12,000 crore for this quarter as well and we have already paid Rs 37,108 crore so it comes to around Rs 49,500-50,000 crore for the year. Q: By when do you think you will get a final word in terms of what the absolute sharing percentage could be because right now the market is working with a 37 percent market share for you or as you said how this works out in a dollar per barrel basis? Vasudeva: We should be hearing it in a day or two. On Thursday or Friday we should be hearing as everyone was only waiting for announcing their results. We also have our board meeting on May 29. We have to declare our annual results so we are waiting for these figures to come. What I was telling was that the first nine months our gross realisation is slightly more than USD 46 a barrel and if the subsidy burden remains at this level, our net realisation would be about USD 46.3-46.5 a barrel which is inadequate. Q: We were just discussing this EPP issue as well and one of the suggestions being made was that companies such as yours also share some of the burden. Your thoughts on whether or not it makes sense for oil companies to shift to the EPP model? Vasudeva: As such we are paying so much that from USD 103-104 gross realisation we are getting only USD 46 per barrel and if we have to pay on account of this EPP or trade parity then our back is going to break. All these IOR (Improved Oil Recovery) and EOR (Enhanced Oil Recovery) projects which we are doing, the additional capex is in the range of USD 7-12 a barrel and you know very well that predominantly our production is coming from old fields where the production is being sustained only through IOR and EOR methods. And this is going to cost us USD 7-12 a barrel. So if we had USD 46 plus this USD 12 would already become something like USD 58 per barrel. Q: My question was relating to FY14 because under recoveries would have come down from Rs 160,000 crore to probably Rs 1 lakh crore this year. It cannot be as much given what has happened with diesel etc. It cannot be as much as FY13. In that scenario do you think the government will still ask you to pay a larger percentage and therefore your absolute payment might be as high as FY13? Do you think your proportionate payment for FY14 will be lower than FY13 which is what your investors want to know? Vasudeva: We would expect that in case the subsidy burdens are reduced on account of the diesel prices being deregulated or this cap on LPG cylinder etc, it is shared pro rata between the government and E&P companies. It should not so happen that just to maintain or to contain that fiscal deficit, the government keeps this thing and we still continue to pay at the old rates. In that case our growth plans will be affected. Q: What have you made of this subsidy sharing plan and the jugglery that the government has to do between fiscal deficit and burdening upstream companies? Parikh: If you look at the macro economic impact of these under recoveries really whose shares make somewhat of a small impact on the total macro economic consequences. I have always argued that government should clearly define and announce a formula so that uncertainty is removed from the side of the oil companies and from the government. It should say it is going to share X percent by ONGC, Y percent by OMCs and the remaining by the government. A clearly defined formula transparent and publically known formula would be in the best interest. And there is really no great loss to the government in doing that. So one cannot understand why this has not been done. Q: The big catalyst for your company of course will be what happens with gas pricing and over there indications are that a USD 6.7 kind of figure may have been agreed upon. Does that seem lucrative to you? Vasudeva: Any price increase is good for producers so we are eagerly waiting for the results of this gas pricing discussions to come out. Q: Do you have any sense of how soon that could happen because we understand that there is a lot of deliberation happening within the government but any indication to you on whether or not that could come into place from FY14? Vasudeva: It is not very clear but very active discussions are taking place are taking place. The compulsions which are there in front of the government because of the impact it will have on power sector and on fertilizer sector. At the same time, if the gas prices don't increase and in case of ONGC predominantly, our production is coming from the old fields which are still being prices at administrated price mechanism (APM). This gas once dwindled cannot be replenished at USD 4.2 a million BTU. The new gas which is going to come will be predominantly from deep waters etc which requires higher price.