The last few months have witnessed lot of developments at policy front in the oil and gas sector. In an attempt to bring down the subsidy bill, the Government is mulling over shifting from the current trade parity pricing (TPP) to export parity pricing (EPP) for key petroleum products like kerosene, petrol and diesel etc . Let us see what it means and implies for different stakeholders.
Under the existing trade parity pricing system, the oil marketing companies consider import parity and export parity in the ratio 4:1 (80%:20%).
While export parity considers benchmark FOB (free on board) prices of the products, import parity pricing (IPP) method includes extra costs like various taxes, duties, transportation charges etc (i.e, the costs that are incurred to import products to Indian ports). As a result, the costs as per import parity method are higher than prices based on export parity method.
Export Parity Price (approx. sum of 1,2,3 in Rs/L)
Trade Parity Price/Refinery tranfer price as per existing method) (80% of (8)+20% of (9))
Current RTP (trade parity basis)
Proposed RTP (export parity basis)
Difference (Current RTP - Proposed RTP (11-12))
Difference in USD per barrel
Total benefits (4a+6+7)
% mark up of trade parity over export parity price
Source : PPAC, Equitymaster
Since the trade parity method uses import parity price and export parity price in the ratio 4:1, the prices as per trade parity method are higher than export parity method.
Impact on under recoveries
The price realized by OMCs (prices in regulated fuel price scenario) less the fuel prices as per trade parity method amounts to under-recoveries currently. If we switch to export parity method, the resulting under recoveries will be much lesser than under the existing system.
Leading to lesser subsidy burden....
As a result of decline in under recoveries (just by shifting the calculation method), the overall fuel subsidy burden is likely to come down. It will be a huge relief for the Government since subsidies are the main culprit behind rising fiscal deficit.
Impact on upstream companies
As of now, there is no fixed subsidy sharing mechanism in place. The share of the upstream companies is decided on an adhoc basis over which the upstream companies have no control. Hence, the benefit of lesser subsidies may or may not be passed on to the upstream companies. Infact, it is quite likely the Government will keep all benefits to itself.
Impact on oil refining companies
Currently trade parity prices are used to calculate refinery gate pricing i.e prices at which petroleum products are transferred from refining to marketing (or price paid by oil marketing companies to domestic refiners for purchase of petroleum products at the refinery gate). Since trade parity pricing method considers import parity (80%) in the calculation, the refiners enjoy some import duty benefit. If a shift to export price parity method does take place, the OMCs will lose on that benefit and it will impact their gross refining margins /GRMs in an adverse manner.
At the same time, in case oil refining companies have to share some under recovery burden (net under recoveries), the move will bring down share in under recoveries (in FY12 , the OMCs shared almost nil under recovery burden).
The oil ministry does not agree with the finance ministry's view on shift to Export parity pricing. It estimates that OMCs will lose around Rs 120- Rs 180 bn if the method is changed. It believes that a mix of export and trade parity will be ideal way for pricing. Looking at the loss figure, it seems unlikely that the proposal will be implemented soon.
Richa Agarwal has over 7 years of experience as an equity research analyst and is the Managing Editor of our small cap recommendation service, Hidden Treasure. She routinely scours the small cap universe for fundamentally strong companies trading at attractive prices. Having degrees in both finance as well as engineering has served her well in analysing business models across the small cap space. Richa is also the specialist in our team for the Oil & Gas sector.
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The explanation about impact on OMCs and Refiners is not clear. It may be better if you explain by actual calculation of underrecoveries. There is a contradiction within the statement "The price realized by OMCs (prices in regulated fuel price scenario) less the fuel prices as per trade parity method amounts to under-recoveries currently. If we switch to export parity method, the resulting under recoveries will be much lesser than under the existing system."
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