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Duty cuts: Impact across the spectrum

Aug 23, 2004

The Indian crude mix is currently hovering at a record high of US$ 42 per barrel as against an average price of US$ 29 per barrel in FY04. As a result of this surging burden on the oil companies, which have been unable to increase product prices for political repercussions, the government announced a spate of duty cuts. Let us now analyze the impact of customs and excise duty cuts on the three segments in the energy business, viz., upstream, downstream (refining and marketing) and stand-alone companies.

Customs duty old (%) new (%)
crude oil 10 10
petrol 20 15
diesel 20 15
LPG 10 5
Kerosene 10 5
Excise duty old (%) new (%)
Petrol 26 23
Diesel 11 8
Kerosene 16 12

Upstream: Although the announcements do not suggest any significant measures for the upstream companies, the major benefits are likely to accrue to ONGC. As a result of custom duty cuts on LPG and kerosene, the landed cost of the two products are likely to reduce resulting in lower subsidies and less discounts from the upstream majors as part of their share towards the subsidy-sharing scheme. Just to simplify, let us take the landed cost of a cylinder at Rs 400 (as per previous customs duty levels at 10%), now with the custom duty at 5%, the cost is likely to reduce. To put things in perspective, ONGC supplied crude to Indian refineries at a discount of nearly US$ 3 per barrel during 1QFY04. Also, the government has not touched upon the custom duty cuts on crude oil, which is another positive for ONGC.

Integrated: Oil refining and marketing companies are likely to be major beneficiaries of these duty cuts are likely to reduce the cost of products to a major extent. It should be noted that major marketing majors such as BPCL and HPCL sell more than their in-house production. This move to cut duties is likely to reduce their costs and at the same time excise duty cuts would help improve margins. The biggest gainer is likely to be IBP, which has no refining capacity but sources its products from IOC.

Stand-alone refineries: Stand-alone refineries, which were hitherto witnessing gross refining margins to the tune of US$ 7 per barrel, would take a hit on the margins as a result of custom duty cuts. A back of the envelope calculation says that the average duty protection, which was nearly 6% before the cuts is likely to reduce to nearly 4% in the current scenario. Margins might be affected to the tune of US$ 1 to US$ 1.5 per barrel. However, margins of US$ 5.5 to US$ 6 per barrel are still high considering the fact that globally refineries enjoy margins in the range of US$ 3 to US$ 4 per barrel.

Private players: Although private players have not yet entered the marketing scene significantly, it would still be improper to exclude this cadre from the ambit of duty cuts as one of them has the largest refinery while the other imports products, thereby the repercussions of duty cuts having significant impact on the business. Reliance Industries' Jamnagar refinery, which enjoys refining margins to the tune of US$ 8 per barrel, is likely to suffer on account of the customs duty cuts, as the protection level shall reduce. However, since the refinery exports a major portion of the produce, it would arrest the impact to some extent. On the other hand, Essar Oil imports its product requirements and customs duty cuts are likely to cheapen purchase costs and improve margins.

All in all, we believe the net impact on the sector is positive. Although refining margins for the integrated players shall squeeze, marketing margins are likely to improve. Further, the government's decision would also reduce the subsidies on LPG and kerosene, which would again arrest the under-recoveries for the segment. All in all, stand-alone refineries are the net losers, as the gross refining margins are likely to reduce.

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Dec 8, 2021 01:13 PM