Lovraj KUMAR Memorial Lecture on “Re-visiting India’s Oil Policy”

Lovraj KUMAR Memorial Lecture on“Re-visiting India’s Oil Policy” For Society for Promotion of Wastelands Development, NEW DELHI29th September 2011

About Lovraj & my relations with Lovraj & Dharma • I consider it a great privilege to deliver the Memorial Lecture for Sri.Lovraj Kumar whom I consider as my mentor in many matters and who has enriched my life. • With the passage of time, I became a good friend but still treated him as my Guru • His commitment to make India one of the most technologically advanced Countries of the World and his contributions to several sectors is well known.

My relations with Lovraj & Dharma The hospitality which he and his wife Dr.Dharma Kumar showered on me and few other young colleagues was a source of great inspiration for us. Having been involved I therefore feel it necessary to re-visit to Energy Policy is necessary in the current National and International Economic and Political Environment.

Why Re-Visiting Energy Policy is Necessary Though my interactions with Sri Lovraj has been known many issues, the subjects which dominated most of our discussions was related to Energy. In some ways I have been involved in the efforts in India in energy policy formulation from my association with the Fuel Policy Committee in 1970. Though India has registered a commendable rate of economic growth in the recent past, its performance in fulfilling basic needs and supplying energy needs of the poorer sections is un-satisfactory. This presentation will explore the efficiency of our energy policy and raise issues on alternate ways for achieving sustained and equitable growth of energy production and consumption.

The sustainability of energy supply is causing anxiety and the search for energy security is being intensified. • Many fear that India’s aspiration to achieve 9-10% annual GDP in the next decade may be constrained by lack of energy supplies • This presentation seeks to explore the feasibility of attaining energy security with reliance on indigenous fuels with minimum environmental adverse effects. • We would examine whether the extrapolation of the policies followed so far are just mimicking the policies of the Developed Countries would be appropriate OR whether some lateral thinking is needed to reshape the Energy Policy of the future

The Energy Policy of India • The Energy Policy of India is spread over several documents and numerous Acts and Notifications. The more recent and relevant for our analysis are the following • The Eleventh Five Year Plan 2007-12 (Planning Commission) • India Hydro-carbon Vision 2025 (Ministry of Petroleum) • The Integrated Energy Policy (2005) (Planning Commission) • The Report of the Committee on pricing and Taxation of petroleum products February 2006 (Planning Commission) • Report of the Expert group on a variable and sustainable system of pricing petroleum products, February 2010 (Planning Commission) • The Report of the Low Carbon Economy (Ministry of Petroleum) • Report of the Expert Group on the Road Map for coal sector Reforms • The Twelfth Five Year Plan approach paper (Planning Commission)

The success of the policies in the energy sector • The success of the bundle of policies in the energy sector should be judged on three different criteria: • Do the policies lead to the production reaching the goals set and imports made as needed to supply all energy needs in adequate quantity and in appropriate forms? . • Do the policies for the production, transport, conversions and final consumption of all energy forms lead to the minimum adverse impact on environment and enhance energy efficiency ? • Do the policies lead to equitable distribution of different forms of energy among the different segments of society and reduce poverty and lead to inclusive growth). • Our attempt this evening would be to examine the extent to which the energy policies as a whole and especially in the Oil Sector have achieved success in these three objectives.

Current Energy GDP Growth The Eleventh Five Year Plan growth has been quite vigorous. Eleventh Five Year Plan might end with confirmed figures of GDP growth of about 8% and energy supply growth of about 7%. The Twelfth plan goals are likely to be set at GDP growth of 8% and a little over 5.5 % growth in energy consumption. How does it compare with the performance in the past

Fuel wise Supply Achievement 1980-2010 Source: Energy 2010: CMIE Publication, MoP&G Documents Notes: a) Figures in bracket in the table represents percentage share of the fuel in TPCES of the year. b) TPCES means Total Primary Commercial Energy Supply. c) Mtoe means Million tonnes of oil Equivalent. d) NG=Natural Gas e) Bkwh= Billion Kilowatt Hours

Fuel wise Supply Achievement 1980-2010

Fuel wise Supply Achievement from 1980-2010

Energy Sector Fuel wise Supply Achievement Source: Energy 2010: CMIE Publication, MoP&G Documents Source: Energy 2010: CMIE Publication, MoP&G Documents

Energy Sector Fuel wise Import Dependence

The success of the policies in the energy sector The analysis drives us to conclude the overall performance of the energy sector in terms of the indicators of success is not satisfactory. Now moving over to the specific fuel sectors I attempted to cover the entire gamut of energy policies relating to Coal, Oil, Gas, Electricity and emerging alternate energy resources. The constraint on time prompted that the discussions are limited to the Oil and Gas sector. This was the sector where Dr.Lovraj Kumar began his career as a technocrat and later as a one of the most respected policy makers in the sector.

Hydro-carbon Vision 2025 • In early 2001, the India Hydro-carbon Vision 2025 laid out comprehensively the policy objectives and action agenda for the Oil Ministry and the Oil Sector PSUs . • The important elements in the Hydro-carbon Vision are: • Focus on oil security through intensification of, exploration efforts and achievement of 100% coverage of unexplored basins in a time bound manner to enhance domestic availability of oil and gas. • Secure acreages(oil blocks) in identified countries having high attractiveness for ensuring sustainable long term supplies. • Open up the hydrocarbon market so that there is free and fair competition, between public sector enterprises, private companies and other international players. • Have a rational tariff and pricing policy, which would ensure the consumer getting the petroleum products at the most reasonable prices and requisite quality, eliminating adulteration. • Restructure the oil sector PSUs with the objective of enhancing shareholder value and disinvest in a phased manner in all the oil sector PSUs. • To develop regulatory and legislative framework for providing oil/gas security 'for the country. • Create a policy framework for cleaner and greener fuels

Production and Availability of Crude Oil

Growth of Refinery Industry 1980-2010 in India Source: Energy 2010: CMIE Publication, MoP&G Documents In a country with inadequate Crude Oil resources and with relatively inefficient port facilities, the refining sector normally grows to meet just the national needs. Suddenly, however in the private sector- without even the required approvals- a refinery which was the world’s largest single unit capacity sprang up. The public sector refinery capacity increased to 111.8 million tonnes while the private sector to 72.5 million tonnes. The total capacity of 184.3 Million tonnes in far in excess of requirements of products within the country and substantial exports are being done from the refinery Industries.

The Profitability of Public Sector Petroleum Companies The Refinery Industry is higher than the needs of the country - refineries export the oil products in surplus to their advantage to export. This establishes that the refinery Industry is very profitable and attractive. This fact needs to be reconciled with the oft repeated statement of officials that the oil Industry is going bankrupt and Government support is propping it up. To answer to the likely question whether there is direct proof that oil companies are making profits we can examine the balance sheets and P&L accounts of oil companies, Given below the profit figures of the highest profit making PSUs in the oil sector Source: Basic Statistics on Indian Petroleum &natural Gas 2009-10 Mo P& NG

The Profitability of Public Sector Petroleum Companies The factual position can be seen when we analyze the profitability of the oil companies from 2002 separately for different types of oil companies which do different functions in the supply chain which brings the oil from the ground through several stages to the retail oil product market. As is well known the Oil companies have been artificially divided into refineries and Oil marketing companies. For reasons which we shall examine shortly under the new price regime called Import Parity Prices (IPP), the total operations of the Industry result in handsome profit at the refinery stage and when they take up marketing of the oil products coming out of the refinery they are incurring the so called “under recovery” because the oil products are not transferred to the oil marketing divisions or other Oil Marketing Companies (OMCs) at the cost of producing the products plus the transport and trade margins as in any other Industry, but are given the right to assume a price which is called Import Parity Price (IPP). This IPP is significantly above the production cost plus the transport and trade. The “under recovery” is made good partly from the upstream oil industries, partly from the oil company, and the rest is made good by the Government.

The Profitability of Public Sector Petroleum Companies This leads to all oil companies ending up with substantial profits as revealed in the table below:

Logic of Import Parity Pricing • In order to understand the mysteries and the logic of IPP price regime which gives rise to these strange and misleading figures we have to trace the pricing system which was followed in India right from the beginning. • Oil Industry in the fifties started with the IPP pricing regime, when most of the oil products were imported. • The 1961 Dalme Committee, the 1965 Talukdar committee repeatedly justified its (IPP) continuance on the ground that India was importing most of its Oil product requirements then and the 1969 Shantilal Shaw Committee had reservations on continuing IPP systems • Dr. Krishnaswamy Committee suggested the abandonment of import parity price for reasons which are worthy of recalling in today’s context. • Dr.Krishnaswamy suggested the adoption of Administered Price Mechanism (APM). The Committee outlined in some detail the method of computing the administered prices.

Administered Price Mechanism • The entire APM was operated through an Oil Pool Account (OPA) maintained by Oil Coordination committee (OCC), wherein inflows and outflows of the pool account were to be kept in balance to provide uniform and stable prices throughout the country. • The major pool accounts in which the oil companies used to adjust their claims and surrenders were: • Crude oil price equalization account (COPE) • Cost and freight (C&F) adjustment account • Freight surcharge pool (FSP) account • Producer price adjustment (PPA) account • On the whole the APM had achieved most of the objectives of a price mechanism such as an orderly growth of the oil industry, continuous availability of products to consumers at fairly stable prices, insulation of marketing companies, refineries and crude-producers from international price fluctuations.

Dismantling APM • The Oil industry especially the Oil Marketing Companies (OMCs) were very unhappy with the long and arduous process of fixing the price of different products in each refinery. • It is in this context of the increasing grievances against the APM procedures in 2004 Dr.Vijay Kelkar took over as the Secretary, Ministry of Oil and Natural Gas. • The context was that the crude Oil price was at a low level (and there was a feeling among some analysts that the crude prices may go down further). Dr. Kelkar felt that the time was right for revision in the oil product pricing system. • Dr. Kelkar set up series of committees • The ‘P’ Committee under Sundarajan then Chairman Bharat Petroleum • The ‘R’ Group under the Secretary himself was to integrate the Oil and Gas sector reform measures suggested by various other alphabet Committees.

Dismantling APM • The ‘P’ Committee recommended the total dismantling of the Administered Pricing Mechanism (APM) and suggested the adoption of Import Parity Prices (IPP) for all products and an Expert Technical Group which we used to refer to as the ‘E’ Group was to work out the dismantling methodology. • The ‘R’ group proposal for the dismantling of the APM and the adoption of Market Determined Pricing Mechanism (MDPM) suggested by the “P” Committee and elaborated by “E” Committee was justified on the following grounds: • Cost plus compensation did not provide strong incentive for cost reduction thereby breeding inefficiencies • There was need to usher in an Internationally competitive petroleum sector in the context of global economy • With the entry of private sector in the refining industry gold plating of the costs would be encouraged under APM regime and this would be remedied by MDPM, • Wide distortion in consumer prices due to subsidies/ cross subsidies would be eliminated in IPP regime. • Adverse impact on oil companies due to huge deficits in Oil Pool Accounts as price revision was not timely under APM regime could be avoided under IPP regime.

Stages In Computing Retail Selling Price • We will now carefully examine if the objectives of MDPM have been achieved in respect of • simplification of computations of determining price of oil products • making the oil companies reduce their costs through improvement in their efficiency • preventing attempts to gold-plate capital and operating costs • avoiding deficits of the type encountered during the operation of the Oil Pool Account. • I will trace first, the stages in computing the price which the customer has to pay at the Retail outlet for oil products. This is determined on a Six stage process as follows: • Step 1 Determine the price of importing Crude into a designated Indian Port. This called Landed Crude Price under the new system • Step 2 Equalise the price of imported crude and the crude produced in India (interim step) • Step 3 Determine the price of crude provided to the Refinery gate (Refinery Gate Crude Price) • (Note: In the refinery the crude is distilled and treated to produce Oil products) • Step 4.Determine the price of different products coming out of the Refinery (Refinery Gate Product Price) • Step 5 Determine the Price at the Storage point (Ex storage point price) • Step 6 Determine the Retail selling Price:

Stages In Computing Retail Selling Price Step 6takes the Ex-Storage point price determined in step 5 as the base and adds the notional railway freight from storage point to the retail selling point to which the State sales Tax/ VAT is added. To this any other State Specific levies are added along with the Dealer Commission. We have arrived at the Retail Selling price which you and I pay for the products Step 5: This involves the simple calculation of the Refinery Gate product price plus the cost of transporting it from the refinery to the designated storage point which becomes the pricing point. Step 4Determining the Refinery Gate Price of different fuels. Logically this should have been based on Refinery Gate price obtained in Step three and should take into account the costs of converting Crude into products and should provide a reasonable margin for the refiner to cover his capital servicing and incentives to take further investment. But under MDPM as implemented there is a total disconnect between the input cost of Crude (by whichever method it is determined) and the refinery output price of products.

Ex-Refinery Gate Product Price • Ex-Refinery Gate Product Price of the product which has no technical connect with the crude prices. This price consists of two parts (1) The Landed Cost of the product and (2) the cost of transferring the product from the port to the Refinery gate. • The Landed Cost of the specific product is the notional cost of importing the product from the Mid-port in Arab Gulf to an Indian port which is nearest to the refinery or is nearest to a designated port. To this is added all charges likely to be incurred in importing the product from the ship into the port storage. It is derived by summing up the figures from the following data: • FOB price as quoted in Arab Gulf Market for the specific product as reported in Platts and Argus trade journal. • Premium / discount as published in Platts or Argus • Ocean freight from mid-port in the Arab Gulf to Indian ports • Insurance • As all these are US $ per barrel, it is converted using the Exchange rate to Rs / barrel • Custom Duty in Rs. • Ocean Loss in percentage • Wharfage and Port Charges in Rs.

Gross Refinery Margin (GRM) In a refinery the total sale value of the product minus cost of inputs and operations is the gross margin of the refinery and expressed normally as the margin per barrel of crude throughput in terms of Gross Refinery Margin (GRM). As this step is important to understand the success of DPDM It is worth explaining GRM in detail. What is GRM?” Here is a hypothetical example. Assume that a refinery processed 1 barrel of crude and derives output in the form of 28 gallon of diesel and 14 gallons of other products (say petrol) and heating oil). Assuming the crude prices are US$ 65 and price of diesel (Refinery gate prices) are US$ 2.0/gallon, while the weighted average prices of other products are US$ 1.4/gallon. Then the GRMs are = (28*2.0 + 1.4*14) – 65 This translates into a GRM of US$ 10.6 per barrel”

If as “R” committee expected the DPDM would lead to a competitive oil market GRM should have declined. In reality this increased See Table below:

Stage 3 of Computing Retail Selling Price • The import parity price of crude oil produced by, say, ONGC, in India is computed as follows: • IPP of crude both produced in India is also fixed with reference to crude of similar qualities, called the “marker “crude, quoted in the Arab Markets. • Get the FOB prices of the respective marker crude US $/ barrel) • add to 1 , The weighted average ocean freight rate calculated from the assessment of freight for VLCCs • add to 2 the following cost elements: • Insurance • Customs Duty • Ocean Loss • Port dues (Wharfage, Port Charges, Landing Charges, Bank Charges etc.) • Oil Company Profit • The total gives the Landed Cost Indian Crude! This is the computation of stage 1. We add to this the internal transport cost from the Port to the Refinery Gate plus the local taxes give the Refinery Gate Price of Crude.

Stage 2 of Computing Retail Selling Price Step 2 – This is an interim step which is relevant only during the period when ONGC and Oil were paid only about 75% of the landed cost of crude determined under step1 which has explained earlier. These complicated procedures lead to a total disconnect in the steps stage of the refinery to marketing. The refiner gets returns based on the computations which begin with the Platt / Argus quoted price of crude in the Arab Market and the computed price of the products which they sell to Oil Marketing Companies (OMCs) to their own marketing divisions.

Government Tax Collections and Expenditure on Subsidies- Oil Sector

Contributions for Compensating the Under- Recovery in Oil industry

I shall attempt to set out some stray thoughts here in the limited time available. • Suggestion one is to bring transparency and improve the understanding of the consumers of the oil product pricing. The bill of sale of each oil product to any consumers small or big should set out the details of the item costs which go into the unit price of the product. • Suggestion two is for a periodic review of the Oil product Pricing System. In countries like Australia there is a periodic appraisal of the methods for computing the import parity price and the validity of the sources from which the data is gathered for computing this figure. • Suggestion three is for a major step of long term importance. The suggestion is to set up a National Natural Resource Commission NNRC to manage all the national natural resources with the short and long term interests of the nation.

……continuation 4. The fourth suggestion is for taking some immediate measures to remedy the most worrying Shortcomings of the existing MDPM system. • The price of diesel and kerosene in the market place should be brought very close to each other reflecting only difference in their processing cost. • The current thinking of providing subsidy to the poor consumers of energy for essential needs in the form of commodity or cash should be replace by providing the energy services at affordable costs by harnessing the tools ,techniques and devices of modern technology.

Coal The recent announcement of a possible shift to the adoption of IPP based procedures of market determined pricing mechanism has created a great deal of worry to the ailing electricity industry and the angry electricity consumers. A senior Consultant in a multinational consultancy firm is reported to have said, “Import price parity will increase the price of power significantly. Almost 65-75 percent of cost of generation is because of coal. But cost of fuel is” pass through”. We have already set out the production of the coal industry over the years in Table 2 To recall see table below:

Coal The sudden increase in coal prices due to Government permitting greater freedom to Coal India in fixing price of coal has resulted in the Profit Before Tax PBT increasing from Rs 5744 Crores in 2008-09 to Rs 13964 Crores in 2009-2010. Unbelievable but true! During the period production increased from 401 million tonnes to 415 tonnes . Makes the story more unbelievable! The story gets murkier when we find the COAL INDIA was dressed up for the Public Offering and that led to the resounding success of IPO and the market capitization of the company pole-vaulting above the then number one namely Reliance industry.

most important issues which would require the attention of the Planning Commission for the development of coal industry • I would list the most important issues which would require the attention of the Planning Commission for the development of coal industry which is key to resolving our energy problems are: • Most of our plans for accelerating coal production are held up in the conflict of interest between the policies of coal development and the policies for preserving the forests. • Some of our coal mine plants are in forest and non-forest land which have for generations supported the livelihood of the inhabitants including tribals. Some of these are based on legal rights while the others may be traditional. • Both the tasks mentioned above could be accomplished only by integrating coal development into the other components of our socio-economic development plan. • In the event of the Planning Commission wanting to pursue the off-the – cuff suggestion for integrating the coal prices with world coal prices it should come out with a detailed paper on: • Which world coal price are we integrating with and why that price is chosen? • The detailed methodology of computing the price from the index source to the Indian point of sale. • How much would be the change from prevailing coal price India – for linked coal and for e-auction price? • What would be the impact of the new price on all downstream industries, especially electricity? • What would the gain or loss to the Coal producer, the coal consumer and the Government and how far this new price regime would further the cause of sustainability and equity.

Conclusion • I would conclude by recalling the suggestions regarding the reform of oil product pricing in the order of sequence in implementation. • Equalisation of the price of Kerosene and Diesel and introduce Smart card or energy Coupons to provide subsidy for the poor at the consumer end. • Enforce the rule of full disclosure of the buildup of the retail price of Petrol and Diesel in each bill. • Appoint a Committee of Technocrats and economists to review the MDPM in oil as it operates today in India. • Appoint a group to work out an alternate route for providing subsidy interms of service based on Solar and energy efficient technologies in place of kerosene and LPG • Initiate action for setting up a National Natural Resource Commission.

Reference to Lov Raj Kumar THANK YOU for your Patience!

Lovraj KUMAR Memorial Lecture on “Re-visiting India’s Oil Policy”