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APM: Where have we come? - Views on News from Equitymaster
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  • May 17, 2003

    APM: Where have we come?

    It has been more than a year since the government dismantled Administered Price Mechanism (APM) on April 1, 2002. This article aims to understand how oil companies, especially PSUs have geared up in order to meet the stiff competition which is expected from the entry of foreign and private players in the downstream oil sector, especially on the marketing front.

    Before the dismantling, the Indian oil and gas sector was under the control of APM. Under this, the prices of four major petroleum products i.e. diesel, motor spirit, kerosene and LPG where controlled by the government. Government charged higher prices on petrol and diesel and cross-subsidized LPG and Kerosene. Consequently, the consumption of LPG and Kerosene increased at a faster pace, as compared to diesel and motor spirit. Hence, the government was faced with rising losses in the form of oil pool deficit (currently Rs 145 bn).

    The process of dismantling took place in following stages as shown in following table. With the dismantling of the APM, the Indian energy companies finally had a chance to price their products, without burdening the government. Of course, the government control on pricing is still there, but in a limited way. Going forward, the industry will be more aligned to the market than ever before.

    The journey so far...
    Event Year
    Administered Price Mechanism introduced 1977
    Oil sector opened up for private players 1991
    Prices of Naptha, FO, LSHS, bitumen and paraffin wax decontrolled 1998
    Exports of petrol and diesel decanalised 1999
    100% FDI in refining sector allowed 2000
    Aviation turbine fuel price is dismantled in April 2001
    APM is dismantled finally 2002

    In the last one-year, prices of the petroleum products have almost tried to match the international crude movements. The prices of petrol and diesel have risen by about 22% and 27% respectively in FY03, though this was less than about 45% rise in crude oil prices internationally. This steep price hike was only the second time in the history of India. In 1990, prices spiked when the government imposed 25% surcharge on petrol and diesel prices.

    In FY03, the hike in the prices was observed on 12 occasions, while the prices were brought down about 4 times. It should be noted that the crude prices internationally remained stronger for most part of the financial year FY03. In an attempt to align the petroleum product prices to international crude prices, the government has initially allowed the PSUs to alter prices on a fortnightly basis. However, with the entry of private players, one can expect to see increasingly short-term volatility in the petroleum prices going forward. This means, that whatever little control the government has on pricing currently, will get diluted as the market becomes more sophisticated.

    A major consequence of deregulation is the entry of private and foreign players in the downstream marketing of the petroleum products. Government has already given permission to Reliance, Essar Oil, ONGC and Numaligarh Refinery to set up retail marketing stations. Recently Shell has also been allowed to set up retail outlets. To put things in perspective, the existing PSU retail outlets in the country number around 20,000. Taking into consideration the permissions given so far, this number is likely to touch 30,000 outlets in the next 5-7 years. It is envisaged that almost 33% of outlets will be in private hands going forward. Currently all outlets are in government hands.

    Outlet capacity snapshot…
    Company Number of Retail outlets
    IOCL 8,100
    HPCL 4,899
    BPCL 4,861
    IBP 1,649
    Reliance 5,849 proposed
    Essar Oil 1,700 proposed
    ONGC 600 proposed
    Numaligarh Refinery 510 proposed
    Shell 2,000 proposed

    Reliance is expected to enter this segment by the end of FY04. Seeing the Group's entry in the telecom business with such aggressiveness, one can expect similar vibrancy when they enter the retail marketing business. Also, once Shell and other foreign players enter this market, the competition will intensify manifold. The biggest beneficiary of this will be definitely the customer. He will see the benefits accruing in terms of product quality, product choices, competitive prices, value added services and convenience.

    PSU marketing companies have taken a lot of initiatives to prepare for the foreseen competition. They have started by taking control from the existing dealer owned network. One can already see them setting up one stop shopping complexes near their retail stations. These companies are also planning to set up new retail stations at the new highway projects like golden quadrilateral, in a bid to pre-empt competition from new entrants.

    Let's look at the consolidated financial performance of the oil PSUs in the first nine months of FY03 (April-December 2002). Increase in the petroleum product prices benefited the companies in terms of rising refining and as well as marketing margins. The combined growth in the topline for HPCL, BPCL and IOC for the nine-month combined was about 10% YoY. This was on account of higher sales volumes and strengthening product prices. Upturn in automobile, commercial vehicles and two-wheeler industry, seems to have triggered higher consumption of petrol and diesel. Bottomline also recorded significant growth for the combined entity (up 140% YoY). The fourth quarter (March quarter) growth trend is also expected to be on similar lines.

    BPCL, HPCL, IOC combined
    (Rs m) 9mFY02 9mFY03 % change
    Net sales 1,433,853 1,570,942 9.6%
    Other Income 11,413 15,402 35.0%
    Expenditure 1,377,196 1,473,030 7.0%
    Operating Profit (EBDIT) 56,656 97,912 72.8%
    Operating Profit Margin (%) 4.0% 6.2%  
    Interest 16,429 9,707 -40.9%
    Depreciation 17,879 19,342 8.2%
    Profit before Tax 33,761 84,265 149.6%
    Extraordinary items -578 0  
    Tax 8,913 28,054 214.8%
    Profit after Tax/(Loss) 24,270 56,212 131.6%
    Net profit margin (%) 1.7% 3.6%  
    No. of Shares 1,417.5 1,417.5  
    Diluted Earnings per share* 22.8 52.9  
    P/E Ratio   5.1  

    Benefits of dismantling apply to players in the upstream market also. The profitability of domestic crude oil producers is exposed to volatility in the international crude price movements. However, since the OPEC wants the crude to stabilise in the range of US$ 22-28, this will benefit domestic producers. A US $1 increase per barrel in realisations, with sales volumes at FY02 level alone is expected to result in an incremental profit of about Rs 8 bn for ONGC. Dismantling came as a boon for ONGC in FY03. Earlier, the company had to sell the crude oil at pre-determined prices (US$ 16 per barrel). Now the company sells crude oil at the prevailing international prices. In FY03, the company saw a 68% growth in net profit as compared to FY02.

    However, on the negative side the government has not been able to keep its promise of setting up a petroleum regulatory board to oversee the sector. Once the regulatory board is set up, it is likely to further boost the developments happening in this sector.

    Thus, the dismantling of APM has brought vibrancy in the downstream side of the oil and gas sector. Oil PSUs are gearing up faster to compete with the private and foreign players, which are expected to enter the markets in the next couple of years. The government efforts of making Indian markets more competitive and aligning them to international standards, is likely to bring in unprecedented development in this segment. Competition has always proved to be a boon to consumers, the recent falling telecom tariffs will vouch for that.



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