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The refining sector - Where are the margins?

Apr 11, 2000

The domestic refining sector witnessed a significant build up in capacity over the last couple of years. Apart from capacity increases in the public sector, private sector companies, led by Reliance Petroleum (27 million tonnes) and Mangalore Refinery & Petrochemicals Limited (9 million tonnes) significantly added to the productive capacity of the sector. However, is the business as attractive as it seems? Letís tackle this issue from the point of view of margins. What determines the margins for the sector? (Before venturing into this it needs to be mentioned that atleast 70% of the revenues of refining companies are from products whose prices are controlled by the government and hence profit margins tend to depend more on factors other than product prices).

A key determinant of refining margins is the import duty differential between crude oil and finished products (like diesel). In India, which imports around 70% of its crude requirements, the duty differential, according to one estimate is just 7% (post budget). This tariff protection is too thin and puts the entire industry at risk to the threat of large-scale imports. The situation seems grimmer if one considers the large buildup in domestic refining capacity.

Nevertheless the refining sector has seen a lot of activity in recent months. This is mainly due to the proposals to deregulate the sector by 2002, permit refineries to enter into marketing (the most lucrative part of the business Ė by one estimate marketing margins post deregulation in the first year could itself increase by almost 200%) and reduce subsidies on petroleum products. Importantly, the government has committed itself to raise the tariff protection to 12-15%.

The refining sector at best offers a mixed bag. If one were to take into account the effect of enhanced competition in pricing of products, margins would be even thinner in years to come. But then the proposed measures have the potential to lift the fortunes of the sector dramatically.


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