Petrol and diesel prices in India have been regulated for a large part of the past decade before recently being de-regulated. In this article, we discuss what de-regulation exactly means and some of the salient features of the pricing of two products in the country as well as the key players and challenges faced by them with the imminent threat of competition from private players after de-regulation.

Petrol and diesel prices in an era of de-regulation

Petrol and diesel prices remained regulated for a large part of the past decade. As a result, while crude prices kept rising for most part, the Indian consumers were somewhat insulated from global benchmark prices with sporadic increases in retail prices. While this helped PSU oil marketing companies, namely BPCL, HPCL and IOCL, to expand their network across India without any threat of competition from private players, large under-recoveries plagued their finances during the period. Additionally, with the Indian economy growing at a rapid pace, demand in the country rose sharply during the period and this led to a large hole in the finances of the union government and subsidies became unmanageable. Consequently, the union government officially de-regulated petrol prices from Jun10, while diesel prices were de-regulated more recently in Oct14.

 

Exhibit 1: Trend of retail price of petrol in Delhi (INR/litre)

Source: Bloomberg, IL&FS Institutional Equities

 

Exhibit 2: Trend of retail price of diesel in Delhi (INR/litre)

Source: Bloomberg, IL&FS Institutional Equities

     

Exhibit 3: Brent crude price (USD/bl)                                    

Source: Bloomberg, IL&FS Institutional Equities

 

Exhibit 4: Subsidy on regulated products (INRbn)

Source: PPAC, IL&FS Institutional Equities


Re-entry of private players likely to be slow
With prices being de-regulated, there has been a lot of interest in the past few months on the potential re-entry of private players such as Reliance Industries and Essar Oil in the retail fuel market, as there is no under-recovery on the products. We note that private players had captured c15% of the total market share in 2005, before exiting the space due to rising subsidies on rising crude prices. However, based on our analysis, we do not expect an aggressive strategy by private players and envisage a 5%–6% market share loss every year by OMCs over the next 24–36 months, restricting private players to 15% of the market by FY18f.
Looking at the typical price build-up of petrol and diesel, we note that fuel retailing costs and the margin charged is only a small component of the overall fuel price.

Exhibit 5: Price build-up for petrol and diesel (INR/lt)

Source: Company, PPAC, IL&FS Institutional Equities

As a result, we have been highlighting in reports to clients that our cost-to-market analysis indicates significantly higher capital costs (thus warranting higher margins) for the private players looking to enter fuel retailing, as against the cheaper legacy assets of OMCs, and higher logistics and operating costs vis-à-vis optimised (multiple refinery locations, product exchange arrangement and use of pipelines) distribution of OMCs; these are likely to set off the benefits of selling fuels in India as against selling them to PSUs or exporting them for private players such as RIL and Essar.

Our channel checks also corroborate our estimates and indicate that while private players, i.e., RIL and Essar Oil, have ramped up volumes at their 2,800 sites that are currently operational, they also appear to be boosting their fuel retailing operations further at a slow pace. Additionally, we note that OMCs operated c49,000 of the 52,000 operational pumps at the end of FY14 and own a bulk of the sites in cities. As a result, it is likely to be extremely difficult for private players to meaningfully ramp up operations in cities, as real estate costs remain prohibitive and the focus is likely to be on highway retail outlets. While we expect OMCs to lose a 5%–6% market share every year to private players, their dominance in the fuel retailing space in India is likely to be retained over the medium term, in our view.

Taxation of auto fuels remains extremely high
The oil sector remains among the highest taxed sectors in the country with substantial contribution to both the central as well as the state exchequers. For the union government, levies include royalty and cess on domestically produced crude oil, profit petroleum on PSC blocks, customs duty on import of petrol and diesel as well as other products, excise duty and service tax apart from corporate income tax and dividend from oil PSUs and dividend distribution tax. Additionally, state governments impose royalty and entry tax/octroi on crude oil along with sales tax/VAT on petroleum products. We note that contribution from the oil sector accounted for INR1.5tn in FY14, c10% of the total union government’s revenue for the year. Additionally, it contributed another INR1.5tn to state governments in FY14.

 
Contribution of the oil sector to government exchequer

(INRbn)

FY12

FY13

FY14

Contribution to central exchequer

1,392

1,426

1,529

Contribution to state exchequer

1,200

1,360

1,525

Total contribution of petroleum sector to exchequer

2,591

2,787

3,054

Source: PPAC, IL&FS Institutional Equities

For FY15, while contribution to the central government is likely to be higher than FY14, as excise duty on petrol and diesel was raised sharply between Nov14–Jan15, the state governments’ revenue is likely to be affected as sales tax/VAT is calculated on advalorem (i.e., percentage) basis and is likely to have fallen sharply due to a drop in crude prices.
The union government’s FY16f revenue from the oil sector is estimated to benefit by INR772bn due to the recent excise duty hikes. We note that the current excise duty rates on both petrol and diesel are at their historic highs. However, we note that it is likely that the government shields retail consumers in a scenario of a sharp rise in crude prices in the future by cutting excise duties.

Excise duty trends on petrol and diesel

Date

Petrol

Diesel

Advalorem (%)

Specific (INR/lt)

Total effective excise duty (INR/lt)

Advalorem (%)

Specific (INR/lt)

Total effective excise duty (INR/lt)

Apr02

32%

7.00

10.53

16%

1.00

2.85

Jun02

30%

7.00

10.82

14%

1.00

2.80

Mar03

30%

7.00

11.81

14%

1.50

3.59

Jun04

26%

7.50

11.97

11%

1.50

3.32

Aug04

23%

7.50

11.90

8%

1.50

3.01

Mar05

8%

13.00

14.59

8%

3.25

4.80

Mar06

8%

13.00

14.59

8%

3.25

4.80

Mar07

6%

13.00

14.66

6%

3.25

4.69

Mar08

Nil

14.35

14.78

Nil

4.60

4.74

Jun08

Nil

13.35

13.75

Nil

3.60

3.71

Feb10

Nil

14.35

14.78

Nil

4.60

4.74

Jun11

Nil

14.35

14.78

Nil

2.00

2.06

Sep12

Nil

9.20

9.48

Nil

3.46

3.56

Nov14

Nil

10.70

11.02

Nil

4.96

5.11

Dec14

Nil

12.95

13.34

Nil

5.96

6.14

Jan15

Nil

14.95

15.40

Nil

7.96

8.20

Jan15

Nil

16.95

17.46

Nil

9.96

10.26

Source: PPAC, IL&FS Institutional Equities

With petroleum products likely to be kept out of GST, at least for the time being, we expect the oil sector to remain among the highest revenue contributors for both the union and state governments, in line with global trends.

Non-fuel retailing could gain significance going forward
While non-fuel revenues do not constitute a meaningful part of retail outlet revenues, they could play an increasingly important role in the future. Our channel checks indicate that OMCs are increasingly pushing their dealers to leverage their prime locations and boost non-fuel revenues. We note that globally, non-fuel sales form c30%–35% of retail outlet revenues. Hence, this remains an area of high potential of growth, which currently remains largely untapped in the country.

 

Saurabh Bharat

Saurabh Bharat is an analyst with IL&FS Broking services pvt. Ltd, based in Mumbai

 



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