Indian Petroleum

2010
Indias Downstream Petroleum Sector

Refined product pricing and refinery investment
InternatIonal energy agency

KIeran clarKe (australIan Department of resources energy anD tourIsm! anD Dagmar grac"yK (Iea!
#$ R K I % & P' P ( R
I%)(R%')I$%'* (%(R&+ '&(%,+

)-e International (nergy 'gency (I('! an autonomous agency was esta.lis-ed in %ovem.er 1/012 Its mandate is two3fold4 to promote energy security amongst its mem.er countries t-roug- collective response to p-ysical disruptions in oil supply and to advise mem.er countries on sound energy policy2 )-e I(' carries out a compre-ensive programme of energy co3operation among 25 advanced economies eacof w-icis o.liged to -old oil stoc6s e7uivalent to /0 days of its net imports2 )-e 'gency aims to4 n Secure mem.er countries access to relia.le and ample supplies of all forms of energy8 in particular t-roug- maintaining effective emergency response capa.ilities in case of oil supply disruptions2 n Promote sustaina.le energy policies t-at spur economic growt- and environmental protection in a glo.al conte9t : particularly in terms of reducing green-ouse3gas emissions t-at contri.ute to climate c-ange2 n Improve transparency of international mar6ets t-roug- collection and analysis of energy data2 n Support glo.al colla.oration on energy tec-nology to secure future energy supplies and mitigate t-eir environmental impact including t-roug- improved energy efficiency and development and deployment of low3car.on tec-nologies2 n ;ind solutions to glo.al energy c-allenges t-roug- engagement and dialogue wit- non3mem.er countries industry international organisations and ot-er sta6e-olders2 I(' mem.er countries4
'ustralia 'ustria Belgium ,anada ,"ec- Repu.lic Denmar6 ;inland ;rance &ermany &reece Cungary Ireland Italy Dapan Korea (Repu.lic of! *u9em.ourg %et-erlands %ew Eealand %orway Poland Portugal Slova6 Repu.lic Spain Sweden Swit"erland )ur6ey Fnited Kingdom Fnited States < $(,D=I(' 2010 International (nergy 'gency
/ rue de la ;>d>ration 0?0@/ Paris ,ede9 1? ;rance
Please note t-at t-is pu.lication is su.Aect to specific restrictions t-at limit its use and distri.ution2 )-e terms and conditions are availa.le online at www2iea2org=a.out=copyrig-t2asp
)-e (uropean ,ommission also participates in t-e wor6 of t-e I('2
2010
Indias Downstream Petroleum Sector

Refined product pricing and refinery investment
)-e views e9pressed in t-is #or6ing Paper are t-ose of t-e aut-or(s! and do not necessarily reflect t-e views or policy of t-e International (nergy 'gency or of its individual mem.er countries2 's t-is paper is a #or6 in Progress designed to elicit comments and furt-er de.ate comments are welcome directed to t-e aut-ors at indiaGiea2org
InternatIonal energy agency

KIeran clarKe (australIan Department of resources energy anD tourIsm! anD Dagmar grac"yK (Iea!
#$ R K I % & P' P ( R
Indias Downstream Petroleum Sector : < $(,D=I(' 2010
)a.le of ,ontents
,-apter 12 (9ecutive summary and introduction 222222222222222222222222222222222222222222222222222222222222222222222222222 ? (9ecutive summary222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 ? Page H @ Introduction 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 I ,-apter 22 Petroleum pricing and Jeffective su.sidiesK in India 2222222222222222222222222222222222222222222222222222 / Petroleum product pricing since t-e end of t-e 'dministered Pricing Lec-anism 222222222222222 / )-e cost of JeffectiveK su.sidies4 under3recoveries to $il Lar6eting ,ompanies 222222222222222 10 Dealing wit- under3recoveries 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 12 ,ontri.ution to fiscal and macroeconomic insta.ility 2222222222222222222222222222222222222222222222222222222222 11 )-e impact of pricing arrangements on downstream development 222222222222222222222222222222222222 1I ' pat- to reformM 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 10 ,-apter @2 )-e downstream petroleum sector4 policy goals and regulatory environment 222222222 1/ Key policy goals in Indian petroleum refining and retail 2222222222222222222222222222222222222222222222222222222 1/ ,reating an Indian li7uid fuels e9porting -u. 22222222222222222222222222222222222222222222222222222222222222222222222 1/ 'n institutional framewor6 for policy ac-ievement and sectoral growt-M 22222222222222222222222222 20 'ssessing Indias downstream sector regulatory framewor6 22222222222222222222222222222222222222222222222 21 ,-apter 12 Indias oil mar6eting companies 222222222222222222222222222222222222222222222222222222222222222222222222222222222 20 $L,s relations wit- t-e &oI 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 20 Structure of t-e $L, sector 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 25 ' .rief description of Indias t-ree $L,s 22222222222222222222222222222222222222222222222222222222222222222222222222222 @0 )-e c-allenge facing $L,s 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @1 $L,s financial performance 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @2 $L,s investment programmes22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @1 'ssessing $L,s4 do $L,s provide for growt- in Indias downstream sectorM 2222222222222222222 @I Pu.lic3 versus private3sector refining 222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @5 ,-apter ?2 #ill India emerge as a maAor glo.al refined product e9porting -u.M 222222222222222222222222 @/ Demand growt- in 'sia3Pacific and t-e Liddle (ast 222222222222222222222222222222222222222222222222222222222222 10 Ledium3term refinery capacity addition in India 22222222222222222222222222222222222222222222222222222222222222222 11 International oil companies and t-e glo.al recession 2222222222222222222222222222222222222222222222222222222222 1@ Implications of Indias growing e9cess capacity 22222222222222222222222222222222222222222222222222222222222222222222 1? Ris6s and c-allenges 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 10 ,onclusion and 6ey findings 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 ?1
,-apter I2 ' return to t-e issue of product pricing4 pat-s toward mar6et reform2222222222222222222222 ?@ Introduction 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 ?@ La6ing mar6ets wor64 t-e secondary .enefits of reform22222222222222222222222222222222222222222222222222222 ?1 )-e possi.le roads to reform (or t-e road less travelled! 22222222222222222222222222222222222222222222222222222 ?? (sta.lis-ing wor6a.le price ceilings in Indian product mar6ets 2222222222222222222222222222222222222222222 ?0 Page H 1 ' transition to li.eralised mar6ets 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 ?5 (pilogue 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 ?/ Bi.liograp-y 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 I1 '..reviations 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 I@
*ist of c-arts
,-art 12 Indian crude product price inde9 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222 / ,-art 22 Fnder3recoveries 200130/ 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 11 ,-art @2 S-aring t-e under3recovery (F3R! .urden22222222222222222222222222222222222222222222222222222222222222222222222 12 ,-art 12 ,entre e9cise vs state sales ta9es 222222222222222222222222222222222222222222222222222222222222222222222222222222222222 11 ,-art ?2 ,omparing magnitudes4 oil sector ta9es under3recoveries and oil .onds 222222222222222222222 1? ,-art I2 &oI sta6e in $L,s 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 25 ,-art 02 Refining mar6et s-are 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 2/ ,-art 52 Retail mar6et s-are 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @0 ,-art /2 Indian product demand 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @2 ,-art 102 $il .ond issuance 2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @1 ,-art 112 Strong 'sian product demand growt- 22222222222222222222222222222222222222222222222222222222222222222222222222 10 ,-art 122 Brownfield refining capacity addition to 2012 22222222222222222222222222222222222222222222222222222222222222 12 ,-art 1@2 &reenfield refinery proAects to 2012 22222222222222222222222222222222222222222222222222222222222222222222222222222 1@ ,-art 112 Indian refining capacity vs domestic demand 200/312222222222222222222222222222222222222222222222222 1I ,-art 1?2 ;orecast 'sia3Pacific refined product e9ports 2012 2222222222222222222222222222222222222222222222222222 10 ,-art 1I2 Indian refining capacity vs domestic demand 201231?222222222222222222222222222222222222222222222222 ?0
*ist of ta.les
)a.le 12 LaAor downstream players 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 2/ )a.le 22 $L,s 6ey financial indicators 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222 @@
,-apter 12 (9ecutive summary and introduction1

(9ecutive summary
9 India maintains price controls on four JsensitiveK petroleum products : petrol diesel li7uefied petroleum gas (*P&! and 6erosene : to insulate consumers against -ig- glo.al crude oil prices2 Indias government3owned $il Lar6eting ,ompanies ($L,s! are tas6ed .y t-e &overnment of India (&oI! to sell t-ese products in retail mar6ets at a centrally3 determined realised sales price2 Fpward revisions to prices in response to -ig-er glo.al crude prices are rare2 's international crude prices .egan structural appreciation from 2001 $L,s .egan recording significant Junder3recoveriesK on t-e sale of sensitive petroleum products2 Fnder3 recoveries are a notional measure representing t-e difference .etween t-e trade3parity refinery3gate cost of refined product paid .y $L,s and t-eir managed sale price2 In ;+ 200530/ $L,s under3recoveries amounted to over FSD 2? .illion2 )-e &oI -as .een forced to issue -undreds of .illions of Indian rupees to $L,s to counteract mass under3recoveries since 200? in order to maintain t-e solvency of t-ese 6ey companies2 )-is -as increasingly occurred via t-e e9tension of off3.udget Joil .ondsK : de.t securities issued to $L,s to .e traded .y t-ese companies for li7uid cas- or to .e used as collateral for .orrowing in financial mar6ets2 )-e &oI issued close to FSD 20 .illion in oil .ond de.t to $L,s in ;+ 200530/2 )-e fiscal impact of under3recoveries resulting from managed product prices -as .ecome acute2 $ff3.udget de.t issuance in particular oil .ond issuance -as led to a fiscal overflow in India2 Indias government deficit (across levels of government and including off3.udget components! more t-an dou.led in nominal terms from ?20N of &DP in ;+ 2000305 to 1121N in ;+ 200530/2 )-is -as greatly reduced t-e fle9i.ility of t-e &oI in responding to t-e current glo.al recession t-reatened to compromise t-e &oIs a.ility to .orrow cost3 effectively in international capital mar6ets and spar6ed fears of Jtwin deficitsK stagnation2 )wo 6ey o.Aectives motivate t-e &oIs policy in Indias downstream petroleum sector4 (a! ensuring Indias growing refined product demand is met at afforda.le prices over time8 and (.! esta.lis-ing India as a maAor glo.al refined product e9porter2 'side from its fiscal implications Indias current petroleum product pricing regime -as implications for t-e ac-ievement of t-ese goals and for t-e emergence of timely refining investments t-at are crucial to t-eir ac-ievement2 )o .egin wit- current pricing practices -ave made pu.lic3sector $L,s reliant on t-e &oI for wor6ing capital from period3to3period2 Despite t-is t-is paper finds t-at $L,s -ave invested strongly in refinery capacity in recent years2 Between 2000 and 2012 : t-e years of Indias 11t- ;ive +ear Plan : $L,s will -ave added over I00 000 .arrels per day (..l=d! in greenfield refining capacity and close to @00 000 ..l=d in .rownfield capacity2 )-is will more t-an matc- Indias rapidly growing refined product demand in t-is period2 )-e $L, sector is t-erefore defined .y -eavy3-anded regulation and lac6lustre commercial performance yet ro.ust investment capacity addition and growt-2 Page H ?
In all t-at follows FS dollar conversions are .ased on t-e average dollar3rupee e9c-ange rate for fiscal
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 9
Page H I 9
Private3sector refinery investment in India too is s-own to .e ro.ust in .ot- t-e recent past and in t-e near future2 ;rom t-e commissioning of Reliance Industry *imiteds (RI*! 2 Damnagar II refinery in late 2005 to t-e sc-eduled commissioning of (ssar $ils Oadinar II refinery in 2012 private3sector refiners will -ave added around 122 million .arrels per day (m.=d! of new refining capacity2 )-is -as .een driven .y4 (a! private3sector refiners scope to profita.ly supply domestic Indian mar6ets .y selling w-olesale to $L,s t-us avoiding e9posure to managed prices8 and (.! Indias significant comparative advantages as a .ase for e9port3oriented refining operations2 's a com.ined result of pu.lic3sector and private3sector refinery investments in t-e recent past India will emerge .y 2012 as 'sias largest refined product e9porter surpassing Singapore2 India will remain one of 'sias two largest refined product e9porters for t-e foreseea.le future2 Indias sudden emergence as a glo.al petroleum producing -u. is li6ely to -ave far3reac-ing implications for regional product mar6ets increasing t-e dept- of product flows and strengt-ening supply c-ains especially for -ig-3end industrial product and clean transport fuels2 )-e esta.lis-ment of Indias large3scale e9port3oriented refining sector mar6s t-e acceleration of a fundamental s-ift in t-e configuration of glo.al refining in w-ic- mature economies increasingly loo6 to production -u.s in 'sia and t-e Liddle (ast to supply incremental refined product demand2 #-ile t-e &oIs downstream policies are li6ely to ac-ieve t-eir am.itious o.Aectives in t-e medium term t-ey -ave done so at a tremendous fiscal cost2 )-ere is an urgent need to reduce t-e fiscal .urden of t-e &oIs system of unofficial petroleum product su.sidies8 to increasingly .ase $L, investment on mar6et drivers and retained earnings rat-er t-an government dictat8 and to foster petroleum product conservation and su.stitution t-rougclear price signals in product mar6ets2 )-e &oI must t-erefore increasingly move towards mar6et3.ased petroleum pricing reform w-ile at t-e same time protecting access to energy mar6ets for more vulnera.le Indian consumers2 Initially t-is will re7uire a concerted com.ination of regulated pricing reform and targeted su.sidies2
Introduction
Bac6ground and structure to t-e study
)-is study provides a -olistic e9amination of pricing and investment dynamics in Indias downstream petroleum sector2 It .egins in ,-apter 2 wit- an analysis of current petroleum product pricing practices in India w-ic- involve price controls on Indias four most3consumed products : petrol diesel *P& and 6erosene2 @ ,-apter 2 a.ove all -ig-lig-ts t-e tremendous fiscal cost of current pricing arrangements2 Cowever t-e e9amination of petroleum pricing in ,-apter 2 (in com.ination wit- ,-apter @ w-ic- e9amines t-e policy and regulatory structures governing Indias downstream sector! also provides t-e analytical framewor6 .y w-ic- sectoral
Reliance Industry *imited (a..reviated to RI*! run .y Lu6es- 'm.ani is one sister company constituting t-e Reliance conglomerate as a w-ole2 )-e conglomerate was split after irreconcila.le differences emerged .etween Lu6es- 'm.ani and .rot-er 'nil w-o once Aointly ran t-e conglomerate2 RI* is t-e .ranc- of t-e original Reliance conglomerate involved in t-e downstream petroleum sector2 @)-ese products ma6e up over I0N of Indian petroleum product consumption2 *P& and 6erosene are t-e 6ey coo6ing fuels outside of .iomass for Indias poor population ma6ing t-em particularly sensitive in a developmental sense2
dynamics of investment and growt- are considered and understood t-roug-out t-e rest of t-e study2 ' compre-ensive consideration of sectoral investment dynamics is underta6en in ,-apters 1 and ?2 )-ese c-apters particularly emp-asise an e9amination of4 (a! t-e a.ility of 6ey downstream companies to meet rapidly growing Indian product demand8 and most importantly (.! t-e prospective emergence of India as maAor glo.al refined product e9porter Page H 0 an outcome wit- considera.le potential implications for t-e evolution of glo.al and regional product mar6ets2 Refinery investment of course is 6ey in .ot- t-ese instances2 ,-apters 1 and ? t-erefore concentrate on investment in refining capacity .y .ot- pu.lic3 and private3sector corporations2 )-e study ends wit- an e9amination of product mar6et pricing policy in ,-apter I2 's will .e argued petroleum pricing policy is entirely unsustaina.le in its current form2 ,-apter I t-erefore returns to t-e issue of pricing originally e9amined in ,-apter 2 and loo6s at potential pat-s towards mar6et3.ased reform along w-ic- t-e &oI may move w-ile at t-e same time protecting energy mar6et access for Indias large poor population2
Setting t-e conte9t of t-e study

#-y e9amine pricing and refining investment in Indias downstream petroleum sectorM 12 India as a glo.ally significant oil consumer4 In 200/ India was t-e worlds fourtlargest consumer of crude oil and petroleum products after t-e Fnited States ,-ina and Dapan wit- product consumption growing .y a remar6a.le ?22N per annum in 200/ despite t-e effects of t-e glo.al recession21 India is forecast to .ecome t-e worlds t-ird largest oil consumer .y 2011 alt-oug- per capita consumption rates are e9pected to remain well .elow $(,D averages2? &iven t-e growing significance of India as a crude consumer it is important to understand and analyse t-e pricing regulatory and investment dynamics at play in its downstream petroleum sector2 )-ese factors will to a large e9tent s-ape domestic supply and consumption patterns currently and into t-e future w-ic- in turn will also largely determine t-e nature of Indias involvement in glo.al energy mar6ets especially refined product and crude mar6ets2 22 )-e impact of oil3sector e9penditures on .udgetary sta.ility4 's mentioned a.ove in ;+ 200530/ Junder3recoveriesK accruing to Indias pu.licly3owned $L,s e9ceeded FSD 2? .illion2 In order to up-old t-e solvency of $L,s t-e &oI -as increasingly issued oil .onds to $L,s2 In Larc- 200/ ratings agency Standard P Poors t-reatened to downgrade Indias sovereign credit rating to JAun6K status due to t-e .allooning of t-e ,entral Budget deficit largely as a result of t-e governments large3scale Joff3.udgetK de.t issuance2 ,urrent downstream sector policy in India t-erefore -as contri.uted tangi.ly to increased fragility and insta.ility in Indias government finances2 )-e issue of petroleum product pricing t-erefore -as significant implications for t-e -ealt- of Indias national .udget and for Indias macroeconomic sta.ility as a w-ole2 #it- India emerging as t-e worlds fourtlargest economy (in purc-asing power parity terms! macroeconomic insta.ility of t-is 6ind is of glo.al concern2
1 ?
International (nergy 'gency (2010! $il Lar6et Report 11 ;e.ruary 20102 International (nergy 'gency (200/! )a.les4 Reviewing Ledium )erm Cori"on : Decem.er 200/ -ttp4==www2oilmar6etreport2org=inde9su.scri.ers2asp
@2 Investment in Indias downstream sector4 Investment in Indias downstream sector will determine t-e a.ility of t-e domestic downstream industry to meet strongly growing Indian refined product demand2 If capacity addition lags demand growt- Indian downstream firms will .e re7uired to draw on glo.al refined product mar6ets to meet product demand compromising Indias energy security putting pressure on under3esta.lis-ed regional refined product supply c-ains (and prices! and mar6edly increasing Indias energy Page H 5 import costs2 Lore significantly from a glo.al perspective t-e nature of downstream investment in India over time will determine t-e success of t-e &oIs am.itious policy to esta.lis- a world3 competitive refined product e9port industry in India .ased on t-e Singaporean model : a process started in earnest already .y RI* (and to a lesser e9tent (ssars! world3leading refinery e9pansions in &uAarat State2 )-e rapid emergence of India as one of t-e worlds largest refined product e9porters -as t-e potential to revolutionise regional product mar6ets especially in w-at will .e termed t-e JIndian $cean rimK8 increase t-e energy security of import3dependent nations8 and fundamentally s-ift t-e configuration of regional refining and product supply3c-ains2
,-apter 22 Petroleum pricing and Jeffective su.sidiesK in India

Page H /
Petroleum product pricing since t-e end of t-e 'dministered Pricing Lec-anism
In 'pril 2002 India a.olis-ed t-e 'dministrative Pricing Lec-anism ('PL! controlling t-e price of petroleum products2 Fnder t-e 'PL product prices were directly administered .y t-e &oI .ased on an opa7ue and comple9 Jcost of operating capital plusK formula2 ,-art 12 Indian crude product price inde9
100 @?0 @00 Price Inde9 2?0 200 1?0 100 ?0 0 'pr302Sep302'pr30@Sep30@'pr301Sep301'pr30?Sep30?'pr3 0ISep30I'pr300Sep300'pr305Sep305'pr30/Sep30/ Date Source4 PP', data -ttp4==ppac2org2in= Petrol Diesel *P& Kerosene ,rude Bas6et
Fnder t-e new regime $L,s would .e free to set retail product prices .ased on an import parity pricing formula2 )-e domestic refining and retail sector was also opened to private3sector firms leading to t-e emergence of a small private3sector retailing presence in India consisting of firms sucas RI*2 Because of t-e importance of *P& and 6erosene as coo6ing fuels for Indias low3income population per unit su.sidies funded from t-e governments .udget were maintained on *P& and on a fi9ed proportion of supplied 6erosene2 Cowever t-ese were to .e p-ased out .etween 200? and 20002 Su.sidies are yet to .e p-ased out2 Fnder t-e new pricing regime it was e9pected t-at retail prices for petroleum products (including prices for domestic 6erosene and *P&! would fluctuate wit- c-anges in t-e price of Indias crude .as6et2 's depicted in ,-art 1 -owever t-is -as not .een t-e case2 I #-ile glo.al crude prices -ave appreciated considera.ly since 2002 retail prices for Jsensitive fuelsK : petrol diesel *P& and
'll data in t-e c-arts included in ,-apter 1 are sourced from Indias Petroleum Planning and 'nalysis ,ell (PP',!2 See4 -ttp4==ppac2org2in=2
6erosene : -ave risen very slowly and in t-e case of *P& and 6erosene -ave -ardly increased at all20 In practice t-e post3'PL product pricing regime .eginning in 2002 was ad-ered to only very .riefly .y t-e &oI in t-ese four 6ey mar6ets2 #it- t-e sustained rise in crude prices .eginning in 2001 t-e &oI increasingly loo6ed to restrict t-e a.ility of $L,s to increase retail prices of t-ese Page H 10 four products so as to protect Indian consumers2 By mid32001 t-e post3'PL model of product pricing -ad .een effectively a.andoned wit- t-e &oI once again centrally controlling upward price revisions2 Since 2001 retail prices for petrol and diesel -ave .een revised upward less t-an ten times .y t-e &oI w-ile *P& and 6erosene prices -ave remained effectively fi9ed25
)-e cost of JeffectiveK su.sidies4 under3recoveries to $il Lar6eting ,ompanies

)-e effect of significantly lower product retail prices t-an crude input prices : a large Jeffective su.sidyK : -as .een t-e increasing accumulation of Junder3recoveriesK .y $L,s2 Fnder3 recoveries are a notional measure representing t-e difference .etween t-e trade3parity cost of refined product paid .y $L,s and t-eir realised sale price2 / In fact t-e actual refinery3gate prices paid .y $L,s are not necessarily congruent wit- formula3.ased trade3parity prices as formally calculated2 )rade3parity prices depend on a variety of factors sucas contract prices and transport costs meaning under3recoveries cannot .e isolated on t-e .alance s-eets of $L,s210 )-ey are an indicative measure of t-e rate of effective su.sidisation2 )-ere -as .een significant de.ate wit-in India over t-e appropriateness of Junder3recoveriesK as a category for measuring t-e .urden of t-e current pricing policy on $L,s2 It is argued t-at t-e refinery3gate prices paid .y $L,s (all of w-om are vertically3integrated refiners! are less t-an trade3parity prices as currently calculated meaning t-e actual effect of managed prices is less t-an t-at suggested .y under3recovery figures2 Cowever t-is de.ate is not of great significance -ere2 )-e 6ey fact is t-at Indian domestic product prices -ave not risen in line witt-e significant generalised increase in international crude prices t-at -as occurred since 200130? and as suc- -ave placed a significant su.sidy .urden on $L,s2 Fnder3recoveries as a
)-e prices of petrol and diesel are protected .ecause of t-e importance of t-ese products as transport fuels (especially as t-ey are widely used in pu.lic transport food freig-t etc!2 Diesel in particular is important as it ma6es up over one3t-ird of Indias petroleum product consumption and -as uses outside transport e2g2 as an input into agricultural production2 5By implication t-e private3sector retail operations t-at -ad .een rapidly set up in t-e aftermat- of t-e dismantling of t-e 'PL were gradually made uneconomical wit- a return of de facto administered pricing2 's a result RI* (ssar and S-ell (t-e t-ree private3sector firms wit- licences to retail in India! were forced to close t-eir retail outlets across India2 /)rade3parity pricing -as replaced import3parity pricing as a .enc-mar6 for pricing calculations since t-e 200I recommendations of t-e RangaAaran ,ommittee as India is .ot- an importer and e9porter of refined product2 Fnder3recoveries on *P& and 6erosene are calculated over and a.ove t-e (relatively insignificant! on3.udget rate of su.sidisation2 $n3.udget allocated su.sidies for *P& and 6erosene are FSD ?I5 million in ;+ 200/310 a significant num.er -owever muc- less t-an total under3recoveries (i2e2 t-e total effective su.sidy!2 10In t-e same way it is important to note t-at under3recoveries and .alance3s-eet losses are not congruent2 *osses are a .alance3s-eet measure w-ic- ta6es into account alternative income streams sucas dividend income pipeline income inventory c-anges profit from freely priced product and refinery margins in t-e case of integrated companies2
category provide a notional indication of t-e e9tent of t-is .urden2 Dust as importantly t-e measure continues to .e used .y t-e &oI to inform policy decisions2 ,-art 22 Fnder3recoveries 200130/
@0000 2?000 Fnder3 recoveries (Qm! 20000 1?000 10000 ?000 0 Kerosene *P& Petrol Diesel )otal
Page H 11
Source4 PP',2
's ,-art 2 s-ows under3recoveries -ave escalated s-arply in recent years from less t-an FSD 10 .illion in ;+ 200130? to close to FSD @0 .illion in ;+ 200530/2 Indeed t-e generalised moderation in crude prices since mid32005 -as not implied a w-olesale reduction in t-e incidence of under3recoveries2 In ;+ 200530/ t-e Indian crude .as6et price averaged Aust over FSD 50=..l2 't current retail prices under3recoveries will .e incurred from any crude price a.ove around FSD ??3I0=..l2 )-e mounting .urden of under3recoveries -as seriously affected t-e operational functioning and financial -ealt- of $L,s2 ;or e9ample .etween 'pril and Decem.er 2005 alone Indias t-ree 6ey $L,s lost .etween 2? and 1@N of t-eir total net wort-211 'lready in 200? it was recognised .y t-e &oI t-at $L,s could not function properly and sustaina.ly under t-e weig-t of .uilding under3recoveries s-rin6ing li7uidity and significantly impaired corporate fle9i.ility2 Instead of .urdening t-e .alance s-eets of $L,s wit- massive under3recovery losses t-erefore t-e &oI -as increasingly loo6ed for alternative solutions to t-e under3recovery issue2 'long wit- re7uiring upstream oil and gas PSFs (Pu.lic3Sector Fnderta6ings! to provide $L,s discounted crude and ot-er tariffs (see JFpstream s-areK in ,-art @! t-e &oI -as increasingly loo6ed to issue off3.udget Joil .ondsK to $L,s to paper over t-e systemic financial and commercial issues reproduced wit-in t-e current product pricing regime2 ,-art @ s-ows t-e incidence of final under3recovery .urden3s-aring over time after t-e &oIs oil .ond remuneration to $L,s -as ta6en place2 12 )-e proportion of t-e under3recovery .urden a.sor.ed .y t-e issuance of oil .onds -as risen rapidly w-ile in ;+ 200530/ financially wea6ened $L,s did not a.sor. any under3recoveries from t-eir .alance s-eets2
11 12
)otal net wort- or J.oo6 valueK refers to t-e total assets minus total lia.ilities of a corporation2 %ote w-ile $L,s were e9empt from a.sor.ing a s-are of t-e under3recovery .urden pu.lic upstream companies were not due to t-e fact t-at -ig- oil prices -ave contri.uted to JwindfallK profits for t-ese firms2
,-art @2 S-aring t-e under3recovery (F3R! .urden

@0000 2?000 Fnder3 recoveries (Qm! 20000 1?000 10000 ?000 0 %et $L, F3R $il Bonds Fpstream s-are )otal $L, F3R
Page H 12
Source4 PP',2
Dealing wit- under3recoveries

$il .onds
$il .ond issuance -as .ecome t-e 6ey fiscal tool for JsolvingK t-e petroleum pricing issue2 In 200530/ t-e &oI issued Aust under FSD 20 .illion in oil .onds to $L,s2 )-e oil .onds issued .y t-e &oI typically -ave maturities of ranging .etween ?30 years alt-oug- maturities can .e up to 20 years2 $il .onds vary in t-eir status of trada.ility2 )-e first oil .onds issued .y t-e government will .egin to reac- maturity from 2010 from w-ic- time t-eir fiscal .urden will .egin to .e felt2 )rada.le .onds are typically sold on .ond mar6ets immediately .y $L,s to generate li7uidity2 %on3trada.le .onds can ot-erwise .e used .y $L,s as collateral to raise cas- alt-oug- .ot- $L,s and Indian .an6s -ave s-own a strong preference for trada.ility2 Indian oil .onds -ave not .een given Statutory *i7uidity Ratio (S*R! status .y t-e Reserve Ban6 of India (RBI!2 )-is means t-ey cannot .e counted as verifia.le li7uid assets in t-e reserves of Indian .an6s to ma6e up re7uisite commercial S*Rs w-ic- -as implications for t-e trada.ility of oil .onds on secondary .ond mar6ets2 'side from t-e significant fiscal conse7uences for t-e &oI implied .y t-e mass issuance oil .onds (w-ic- will .e e9amined .elow! t-is process -as also not proved to .e t-e commercial panacea for $L,s financial pro.lems as -oped2 Despite a general climate of falling interest rates in 200/ and increasingly ris6 averse financial practices : conditions w-ic- ceteris pari.us s-ould support t-e face value of e9isting sovereign de.t : $L,s -ave -ad great difficulty li7uidating oil .onds for t-e full value of t-e coupon as issued2 )-ere are two 6ey reasons for t-is4 9 Saturated .ond mar6ets4 Several years of massive oil farm and fertiliser .ond issuance .y t-e &oI -ave created a significant .ond mar6et glut in India2 $L,s -ave t-erefore -ad to compete in .uyers .ond mar6ets to sell t-eir fi9ed3yield assets leading to falling .ond prices2
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 9 %on3S*R status4 's mentioned t-e RBI precludes oil .onds from S*R status21@ )-is non3S*R status -as meant t-at in t-e conte9t of .ond mar6et over3supply Indian .an6s and financial institutions -ave s-own little ent-usiasm for large3scale ac7uisition of fi9ed3yield oil .onds as t-ey -ave .een issued forcing $L,s to discount .ond values2
Indian policy ma6ers -ave .egun to ta6e ad -oc steps to reform t-e current conditions under Page H 1@ w-ic- $L,s li7uidate oil .onds in open mar6ets2 In particular t-e &oI -as soug-t to agree arrangements wit- t-e RBI under w-ic- t-e RBI would a.sor. e9cess oil .ond supply2 In particular wit- $L,s struggling to generate t-e foreign e9c-ange (fore9! li7uidity necessary to purc-ase imported inputs especially crude t-e government -as as6ed t-e RBI to ma6e .ond3 for3fore9 swaps at prevailing mar6et rates2 's t-e situation stands -owever t-e losses made .y $L,s on .ond values only serve to -eig-ten t-e fiscal impact of Indias current petroleum pricing regime2 's .ond values fall and $L,s a.ility to use t-ese assets to a.sor. t-e impact of under3recoveries lessens t-e &oI is inevita.ly forced into yet furt-er rounds of de.t issuance2
Rationalisation of ta9es and duties

In order to lessen t-e under3recovery .urden on $L,s t-e &oI -as loo6ed to rationalise t-e comple9 system of ta9es and duties on petroleum products in tandem wit- large3scale .ond issuance2 ,learly given a centrally administered retail price for petroleum products a reduction in t-e proportion of realised prices t-at are made up .y ta9 will reduce t-e under3recovery accruing to $L,s211 ;or e9ample .etween t-e end of 2001 and Dune 2005 t-e &oI .roug-t e9cise ta9 on petrol down from a rate of 2IN ad valorem plus I%R 02?0 per litre to a flat rate of I%R 1@2@? per litre2 (9cise on diesel was reduced .y a similar magnitude2 (9cise on *P& and 6erosene was reduced from 5N and 1IN respectively in 2001 to nil .y mid320052 Between 2001 and Dune 2005 t-e &oI also reduced t-e customs duty on imported petrol and diesel from 20N ad valorem to 22?N2 )-is is furt-er to a.olis-ing custom duties on *P& and 6erosene in early3200?2 ,ustoms duty on imported crude was reduced to nil in Dune 20052 'cross levels of Indian government -owever t-e rationalisation of petroleum product ta9es and duties -as .een considera.ly un.alanced and uneven2 #-ile t-e &oI -as s-own a willingness to cut into revenues to -elp deal wit- petroleum pricing issues state governments -ave .een mostly unwilling to undermine t-is relia.le inelastic source of revenues2 #-ile states -ave almost uniformly moved from an ad valorem sales ta9ation structure to a flat3rate structure (in order to reduce pressure on prices in times of rapidly increasingly crude costs! t-ey -ave aimed to ensure t-at total revenue -as not .een undermined2 )-us as ,-art 1 s-ows since 200?30I t-e &oIs e9cise revenues -ave plateaued and even declined marginally as e9cise ta9 rates -ave fallen w-ile total sales ta9 revenues accruing to states -ave s-own strong growt-2
1@
Some Indian commentators -ave suggested t-at t-e RBI -as deli.erately persisted wit- t-e e9clusion of oil .onds from S*R status to protect t-e demand for t-e &oIs .orrowings given current macroeconomic uncertainty and .ond mar6et glut2 11's reported in an I(' paper (-ttp4==www2iea2org=papers=200/=petroleumRpricing2pdf! t-e ta9 collected on petroleum products significantly outweig-s t-e su.sidies on t-ese products and represents a significant source of revenue for .ot- central and state &overnments2 )-e rate of ta9ation -as 6ept Indian retail prices relatively compara.le (alt-oug- still lower for all 6ey products! to neig-.ouring countries sucas Pa6istan and Banglades-2
,-art 12 ,entre e9cise vs state sales ta9es
000000
Page H 11
Revenue (Lillions Rs2! ?00000

100000 @00000 200000 100000 0 )otal (9cise Revenue (,entre! )otal Sales )a9 Revenue (State!
I00000
Source4 PP',2
)-ere is t-us an emerging issue of Jvertical fiscal im.alanceK wit-in Indias system of petroleum mar6et regulation2 $n t-e one -and t-e &oI is systematically cutting ta9ation revenues w-ile rapidly increasing outlays (in t-e form of oil .onds! to deal wit- in-erent petroleum pricing issues2 $n t-e ot-er -and state governments continue to reap ta9 revenues from t-e petroleum sector w-ile offering no financial support for t-e crippling system of effective su.sidies2 ,learly under3recoveries suffered .y $L,s would -ave .een larger in t-e last several years -ad t-e &oI not soug-t to reduce ta9es and levies on petroleum products2 %evert-eless simply cutting ta9ation rates cannot solve t-e underlying issue of a.sent cost3reflectivity in product mar6ets2 By cutting ta9es t-e &oI t-erefore ris6s undermining a crucial source of revenue w-icmay .e spent in support of .asic developmental programmes w-ile providing only a very partial and incomplete solution to t-e petroleum pricing issue2 In fact .y cutting ta9es it undermines its a.ility to fund t-e rapidly increasing outlays re7uired to support t-e su.sidies regime an idea e9plored .elow2 *astly reducing ta9es now will ma6e it very difficult for future governments to raise ta9ation rates on petroleum products in t-e future depriving policy ma6ers of a 6ey demand3side management and environmental policy tool2
,ontri.ution to fiscal and macroeconomic insta.ility

*arge3scale under3recoveries accruing to $L,s and massive oil .ond issuance are -ig-ly desta.ilising to t-e Indian central government finances and for Indias macroeconomic -ealt- in general2 's ,-art ? s-ows in 200530/ under3recoveries are rapidly encroac-ing on total ta9 collected (.y state and central governments! from t-e oil and petroleum sector for t-e first time21? )-is is not surprising2 #-ile under3recoveries -ave risen at a worrying pace t-e &oI -as
1?
)-is includes ta9es accruing on t-e w-ole range of petroleum products not Aust t-e four JsensitiveK products2 It also includes ta9es accruing at all levels of government2
forcefully cut petroleum product ta9ation2 #it- rising e9penditure o.ligations and falling revenues t-e net a.ility of t-e petroleum sector itself to fund current pricing arrangements is t-erefore rapidly .eing eroded t-us forcing t-e &oI to consolidate spending in ot-er areas of its .udget or rat-er as it -as s-own itself willing to do to issue significant 7uantities of off3.udget de.t2 ,-art ?2 ,omparing magnitudes4 oil sector ta9es under3recoveries and oil .onds Page H 1?
1?000 10000 @?000 @0000 Lillions FSQ 2?000 20000 1?000 10000 ?000 0
20013200? 200?3200I 200I32000 200032005 20053200/
)a9 )otal F3R $il .onds
Source4 PP',2
)-e moderation of international crude prices since late32005 -as eased t-is situation (wit-out removing it!2 In early 200/ private3sector retailers even .egan re3opening previously closed retail outlets across India alt-oug- t-e re.ound in crude prices from mid3200/ largely ended t-is process2 ;urt-er in contrast to official intransigence to sanction upward price revisions under conditions of rising prices t-e &oI s-owed itself to .e willing to 7uic6ly and apprecia.ly revise down product prices in an environment of falling glo.al crude prices (as seen clearly in late32005 and early3200/!2 #-en t-is occurs $L,s are not significantly .etter3off as a result of crude price moderation2 Lounting oil .ond de.t -as led to a period of considera.le .udgetary e9cess in India2 #it- ta9 revenues falling stimulus spending accelerating and off3.udget de.t issuance increasing rapidly Indias government deficit (across all levels of government and including off3.udget components! more3t-an3dou.led in nominal terms from ?20N of &DP in ;+ 2000305 to 1121N in ;+ 200530/2 )otal state and central government de.t is estimated at 52N of &DP2 's rating agency Standard P Poors (SPP! is 6een to -ig-lig-t t-e 6ey factor in t-is fiscal e9cess is t-e rapid increase in off3.udget de.t issuance and in particular oil .ond issuance2 1I 'ccording to SPP JIndias fiscal deficit is entirely unsustaina.le in t-e medium3termK2 10 It -as warned t-at wit-out tangi.le signs of fiscal tig-tening it will downgrade Indias sovereign credit from BBB (its lowest investment grade! to JAun6K status2 ' downgrade of Indias sovereign credit
1I
So3called Jfertili"er .ondsK : similar to oil .onds .ut issued to farmers to offset t-e increasing cost of fertili"er and ot-er petroc-emical feedstoc6s : amounted to close to FSD 10 .illion in ;+ 200530/2 10Standard PPoors (200/! JIndia Sovereign ,redit Rating4 Press ReleaseK ;e.ruary2
rating will only worsen t-e effect of large3scale oil .ond issuance on t-e -ealt- of government finances2 's a result of several years of accumulated off3.udget de.t issuance interest payments on government de.t already consume around 21N of general government revenue2 Sovereign JAun6K status will force investors to demand -ig-er interest rates on Indian government paper .ot- for oil .onds ot-er off3.udget de.t issuance and general government Page H 1I .orrowings : w-ic- itself will increase t-e proportion of t-e &oIs revenues devoted simply to interest payments on de.t2 ;urt-er if as e9pected oil .onds are given greater S*R status general government .orrowings will -ave to compete wit- t-ese securities for .uyers : again putting upward pressure on government paper interest rates2 )-is situation of serious .udgetary insta.ility is currently com.ined wit- cyclical wea6ness in t-e Indian economy2 'fter averaging over 0N &DP growt- .etween 200@ and 2000 Indias growtfell to I2IN in ;+ 200530/215 #it- Indian e9ports -it -ard .y falling demand in 6ey mar6ets Indias current account deficit widened apprecia.ly to @20N of &DP in 200530/2 )-e emergence of Jtwin deficitsK in India especially of a large fiscal deficit -as caused countless commentators to compare Indias current situation wit- t-at e9perienced in t-e lead3up to t-e J&ulf #arK .alance3of3payments crisis in 1//12 In fact Indias current economic positioning is 7uite different to t-at e9perienced in t-e late31/50s not least in t-e relative resilience of its e9ternal position2 Fnder current economic conditions -owever recent fiscal profligacy is li6ely to limit t-e &oIs options regarding furt-er direct economic stimulus as well as to put significant downward pressure on t-e rupee2 Indias position is t-erefore in contrast to t-e fiscal situation of ,-ina w-ic- despite considera.le stimulus spending in 200/ is ro.ust enoug- to provide scope for stimulus into t-e future if necessary and to avoid t-e need for strict fiscal austerity in t-e aftermat- of t-e glo.al recession2
)-e impact of pricing arrangements on downstream development

,urrent policies wit-in Indias downstream petroleum sector clearly -ave implications for investment decisions wit-in t-is sector w-ic- in turn will determine t-e way t-e sector evolves in t-e medium3term2 Fnder t-e current system $L,s are largely dependent on indirect -and3 outs from t-e &oI for wor6ing capital2 )-e repeated e9tension of t-is is t-e result of a range of uncertain political processes2 )-e e9tent to w-ic- t-is affects t-e willingness and a.ility of $L,s to invest in additional capacity and tec-nology or to conduct productive long3term planning will .e e9amined in ,-apter 12 #ill current investment effectively allow for sectoral growt- and meet rapidly e9panding Indian petroleum demandM 'nd w-at role does t-e current system of pricing play in informing investment decisionsM ,-apter ? will loo6 at t-e downstream investment plans of private3sector refiners in t-e conte9t of w-at is presented in t-is c-apter to e9amine t-e potential for India to emerge as a glo.al refining centre and li7uid fuels trading -u.2 )-e following c-apter will lay t-e foundation for t-ese analyses of sectoral investment dynamics .y outlining t-e policy and regulatory framewor6s governing Indias downstream sector2
15
Source4 )-e Cindu (200/! JIndia cloc6s I2I percent growt- in 20053200/K @0 Lay2 &DP figures for 200530/ do not reflect Indias growt- trend from 200@ .ecause t-ey were affected .y t-e financial crisis late in t-e second -alf of t-e calendar year2 %eit-er -owever do t-ey reflect t-e full impact of t-e glo.al recession on t-e Indian economy as growt- remained strong for t-e first -alf of 20052
' pat- to reformM

)-ere -as .een considera.le tal6 of reform to petroleum product pricing arrangements since t-e re3election of t-e ,ongress3led government in Lay 200/2 ;or a significant period .efore elections were -eld t-e government deferred ma6ing maAor reform decisions t-at mig-t incite t-e electorate2 Cowever Prime Linister Sing- and -is ,a.inet -ad reiterated t-eir commitment Page H 10 to reducing government controls on fuel pricing in late32005 as part of a review of t-e Integrated (nergy Policy of 200I (I(P!2 ' proposal for pricing reform emanating from t-e Linistry of Petroleum and %atural &as (LP%&! was circulated immediately following t-e 200/ election2 )-e proposal suggested t-at $L,s set product prices every t-ree mont-s .ased on t-e 7uarterly average price of t-e Indian crude .as6et2 )-is it was proposed would occur until crude reac-ed FSD 0030?=..l at w-icpoint t-e government would again implement price3caps to protect consumers2 Developments in international crude mar6ets -ave since overta6en t-e proposal effectively ma6ing it unsuita.le at least for t-e present2 #it- t-e insufficiency of t-is proposal actual downstream reform in t-e time since t-e government was re3elected -as .een marginal and piecemeal2 )-e government -as for e9ample loo6ed wit- $L,s to enforce t-e 7uantity restrictions on 6erosene : so not more t-an t-e set 7uantity is sold at su.sidised prices2 ;urt-er as part of t-e new governments first .udget (for ;+ 200/310! Indias ;inance Linister announced appro9imately FSD 2 .illion would .e set aside to compensate $L,s for t-eir losses under current pricing arrangements2 )-is is a sign t-at t-e &oI is .eginning to .ring off3.udget su.sidisation onto t-e official .udget itself2 )-e magnitude of t-is .udgeted su.sidisation -owever is clearly insufficient given t-at oil .ond issuance in 200530/ was close to FSD 20 .illion2 's part of t-e .udget speec- t-e &oI announced it would set up a committee to Jadvise on a via.le and sustaina.le system of pricing petroleum productsK21/ )-is committee -eaded .y eminent Indian economist Kirit Pari6- recently released its findings2 It sets out a .old vision for reform of t-e product pricing including t-e immediate li.eralisation of petrol and diesel mar6ets2 )-e practical impact of t-is am.itious reform statement (-ereafter t-e JPari6ReportK! remains to .e seen and indeed analysts -ave reason to .e sceptical of its potential influence on &oI policy2 Since 200I t-e recommendations of several committees convened on t-is su.Aect no less .old in scope -ave failed to alter t-e &oIs petroleum sector policies2 Petroleum product pricing policy t-erefore seems to .e in a situation of stasis at present2 )-e moderation of international oil prices in early 200/ too6 some of t-e fiscal pressure from t-e issue wit- under3recoveries decreasing slig-tly and $L,s re7uiring less financial assistance from t-e government2 Indeed in t-e first 7uarter of ;+ 200/310 Indian $il ,orporation Indias largest $L, recorded one of t-e largest 7uarterly profits in its -istory2 In t-e second -alf of 200/ -owever oil prices again trended strongly upwards and $L,s again .egan to record large under3recoveries2 Fnder3recoveries for ;+ 200/310 are currently e9pected to .e in t-e order of FSD 1? .illion2 's long as tig-t supply3demand .alances remain as e9pected a medium3term feature of glo.al crude mar6ets petroleum pricing will continue to .e an issue for Indias government eventually re7uiring fundamental pricing policy reform to solve2 )-is issue will .e returned to in ,-apter I2
1/
Linistry of ;inance (200/! Fnion Budget Key (9cerpts I Duly2
,-apter @2 )-e downstream petroleum sector4 policy goals and regulatory environment
Page H 1/ Before growt- trade and investment dynamics of Indias downstream petroleum sector can .e analysed it is necessary to outline t-e policy goals defined .y t-e &oI for t-e sector2 Similarly t-e regulatory framewor6 t-at is in place .ot- governing t-e sector and assisting in t-e ac-ievement of t-ese policy goals needs to .e outlined220
Key policy goals in Indian petroleum refining and retail

)-e government of Indias 11t- ;ive3+ear Plan (covering t-e years 2000312! .uilds on t-e I(P of 200I to outline t-e 6ey policy goals for Indias refining and retail sector2 )-ese policy goals are fourfold4 12 Lar6et3.ased pricing t-roug-out t-e downstream value3c-ain2 22 Significantly en-anced refining capacity to4 (a! meet growing Indian demand in order to allow economic growt- and standard of living appreciation8 and (.! esta.lis- India as a competitive li7uid fuels e9porter to ta6e advantage of e9panding fuels demand in (ast3 and Sout-3(ast 'sia2 @2 (nsuring Indian refineries are e7uipped to process c-eap sour and -eavy crudes w-ile still producing internationally3recognised clean3product grades2 12 Laintaining a streamlined ena.ling sectoral regulatory framewor6 t-at stimulates private3 sector and Aoint3venture investment in order to meet goal (2! a.ove2
)-e issues surrounding Policy &oals 13@ of t-e 11t- ;ive3+ear Plan are e9amined elsew-ere in t-is study2 ;or e9ample ,-apter 2 e9amines t-e issue of pricing t-roug- Indias downstream sector2 Investment dynamics relating to domestic and e9port3oriented refining referred to .y Policy &oal 2 are e9amined in detail in ,-apters 1 and ? respectively2 Production of internationally recognised clean fuel grades (Policy &oal @! is an integral part of t-ese investment dynamics221 Policy &oal 1 will .e discussed .elow in t-is c-apter2
,reating an Indian li7uid fuels e9porting -u.

#it-out dou.t t-e most pervasive issue in t-e Petroleum and %atural &as c-apter of Indias 11t- ;ive3+ear Plan is t-e proposed esta.lis-ment of India as a world3competitive e9porter of refined products : as articulated in Policy &oal 2(.! a.ove2 $ne of t-e few t-rust areas for t-e
20
,-apter 2 confined analysis primarily to Indias four most consumed and su.sidised petroleum products : petroleum diesel 6erosene and *P&2 Since t-is c-apter is concerned wit- policy and regulation in t-e downstream sector as a w-ole t-is specification will not .e made -ere2 21It s-ould .e noted -ere t-at from t-e .eginning of ;+ 2010311 t-e &oI will enforce (uroIII fuel norms across India and (uroIO norms for all maAor cities2 $L,s current refineries are .eing upgraded to allow for t-is w-ile all greenfield refineries planned including $L,s refineries are re7uired to comply witproduction of t-e -ig-est grade auto fuels (i2e2 (uroO and a.ove!2
petroleum and natural gas sector as a w-ole is t-e Jpromotion of India as a competitive and economically via.le refining destination to service .ot- t-e domestic and e9port mar6etsK a proAect t-at rests on t-e emergence of e9cess refining capacity in India in t-e medium3term2 22 )-e Plan states t-at Jt-e Linistry Sof Petroleum and %atural &asT and companies are ta6ing t-e initiative to e9plore t-e potential for an e9port -u. in India .ased on t-e e9port opportunities 2@Page H 20 availa.le in (urope and 'siaK2 )-e Plan includes a cost3.enefit analysis for emerging e9port refining capacity in India and concludes t-at Jit is an opportune moment for t-e domestic refining industry to ta6e on t-e c-allenge and to ma6e India a maAor glo.al refining destinationK221 Indias emergence as a world3competitive li7uid fuels e9port -u. depends on large3scale refinery investments .y .ot- $L,s and private3sector refiners2 ,-apter ? will e9amine in detail t-e potential for investment of t-is scale2 $f course t-e ac-ievement of -ig- levels of investment in e9port3oriented refinery capacity is in turn partly reliant on t-e regulatory conditions facing Indias downstream sector2 )-e regulatory framewor6 governing t-e downstream sector is outlined .elow2
'n institutional framewor6 for policy ac-ievement and sectoral growt-M

)-e 6ey day3to3day role of t-e &oI in t-e downstream petroleum sector (outside of its arms3 lengt- control of $L,s! is to provide an ena.ling regulatory framewor6 t-at fosters certainty timely investment and growt- in t-e sector2 In t-is way Policy &oal 1 is critical to ac-ieving t-e ot-er maAor Policy &oals and especially t-e o.Aective to esta.lis- India as a refining -u.2 's t-e 11t- ;ive3+ear plan notes Jactual capacity additions depend on several factors including U regulatory conditions duty structure and refining marginsK2 2? )-is section will .riefly outline t-e regulatory framewor6 governing Indias downstream sector2 It as6s4 to w-at e9tent -as t-e &oI put in place structures and institutions to meet its 6ey policy goalsM #-at is t-e nature of t-e regulatory framewor6 governing t-e downstream petroleum sectorM
Downstream regulation
)-e Petroleum and %atural &as Regulatory Board (P%&RB! was esta.lis-ed in 2000 as t-e downstream sector regulator tas6ed wit- regulating t-e refining processing storage transportation distri.ution mar6eting and sales of petroleum products and natural gas2 It does not -owever aut-orise refinery infrastructure construction w-icis controlled .y LP%& and -as no role in mar6et pricing or pricing policy2 )-e 6ey practical function of t-e Board relates to (a! its role as court of ar.itration in disputes wit-in t-e downstream sector8 and (.! its powers
22 2@
Planning ,ommission (2000! JPetroleum and %atural &as ,-apterK (levent- ;ive3+ear Plan pp2 2312 I.id2 p2 @2 21'lt-oug- t-is is now official government policy Indias Planning ,ommission -as e9pressed concerns in t-e past a.out t-e development of e9cess refining capacity in India given t-e considera.le uncertainty in glo.al product mar6ets2 )-e ,ommissions concern is t-at after very costly investment in additional refining capacity $L,s may face a situation of structural glo.al e9cess refining volume as new capacity emerges in t-e Liddle (ast and (ast3 and Sout-3east 'sia2 )-ese competitiveness issues will .e e9amined in ,-apter ?2 2?I.id2 p2 2/2
to release tenders for and grant of aut-orisation to lay .uild operate and e9pand cities natural gas distri.ution networ6s2 P%&RB -as powers to investigate and litigate against downstream operators for monopolistic .e-aviour8 register entities to mar6et and retail petroleum products and monitor t-ese entities for cases of adulteration8 aut-orise operators to lay product pipelines and determine w-et-er pipelines are private3 or common3carrier (.ased on specific criteria!8 and regulate access to Page H 21 pipelines and pipeline transportation rates2 P%&RB also monitors prices t-roug- t-e downstream value3c-ain including t-e ad-erence to ma9imum prices set .y t-e &oI8 and determines and enforces tec-nical standards and specifications relating to downstream activities2 )-e esta.lis-ment of P%&RB is clearly a necessary step in t-e evolution and maturation of Indias downstream sector providing investors wit- greater legal certainty and more transparent regulatory oversig-t and ar.itration2 Some critics -owever -ave accused t-e &oI of esta.lis-ing a Jtoot-lessK P%&RB wit-out aut-ority over t-e two 6ey areas of product pricing and refinery investment2
Downstream .usiness environment

)-e 6ey aspects of Indias .usiness environment are e9amined .elow4 (a! ;oreign investment policy4 Indias foreign investment regime -as .een li.eralised significantly since t-e late31//0s2 'll private3sector refining proAects -ave automatic foreign investment approval and may .e 100N foreign3owned2 In t-e case of Pu.lic3Sector Fnderta6ings -owever foreign e7uity -as to .e approved .y Indias ;oreign Investment Promotion Board (;IPB! and cannot e9ceed 1/N of total owners-ip2 )ransactions on t-e current account are fully converti.le t-oug- India retains several controls on capital account converti.ility2 #-ile India -as considera.ly increased t-e access of foreign investors to Indias downstream sector t-roug- li.eralisation of foreign investments approval process t-ere remain significant J.e-ind3t-e3.orderK .arriers to investment2 #-ile foreign capital proAects may .e approved fairly simplistically once approved proAects are re7uired to meet a significant num.er of c-angea.le opa7ue comple9 and slow3moving state and &oI aut-orisations and procedures for insurance purposes demograp-ic and environmental impacts ta9 compliance la.our standards etc2 )-is considera.le red3tape acts as t-e 6ey .arrier to investment in India2 Indias Special (conomic Eones (S(Es! and (9port3$riented Fnits (($Fs! (see .elow! were esta.lis-ed largely to assist .usinesses investing in 6ey industries to s6irt t-is e9tensive red3tape2 (.! )a9 policy4 India maintains a relatively cum.ersome ta9 regime compared to similar economies (see for e9ample ,-ina and Indonesia!2 )-e standard corporate ta9 rate is -ig- at 12N and t-e ma9imum personal ta9 rate is also -ig- at over @@N22I ,apital gains on assets -eld for less t-an t-ree years are ta9ed as income2 *ong3term gains are ta9ed at 20N2
2I
Importantly under Indias Income )a9 'ct t-e &oI ma6es dispensation for a seven3year 100N ta9 -oliday on profits derived from underta6ings involved in t-e production or refining of Jmineral oilsK (i2e2 crude! t-at is esta.lis-ed wit-in an allowed timeframe2 )-is clause in t-e 'ct was set to e9pire in 200I and again in 200/ .ut -as .een e9tended to 20122 )-e &oI -as indicated t-at it will not e9tend t-e clause after 2012 alt-oug- policy ma6ers -ave -inted t-at it mig-t .e e9tended for some time after 2012 in practice2
Lost significant -owever is t-e myriad of ta9es and duties levied on various products and imports and e9ports of products2 't t-e level of t-e central government domestically produced petroleum products are su.Aect to a central e9cise ta9 additional e9cise ta9 and a special additional e9cise ta9 : eacof w-icis different from product to product2 't t-e state level products are t-en su.Aect to a O') t-e rate of w-icis different from state3to3state and from Page H 22 product3to3product2 Products are also su.Aect to a variety of ot-er ta9es at t-e discretion of states : sucas for e9ample Jentry ta9K in Fttar Prades- and Lad-ya Prades- and JDevelopment )a9K in Caryana220 Product is also su.Aect to city ta9es and levies in some locations e2g2 ,-ennai and Cydera.ad2 ;inally imported petroleum products are su.Aect to various rates of customs duty additional customs duty and special additional customs duty eacof w-icis different from product3to3product2
)-is comple9 c-angea.le and -ig-ly3differentiated tangle of ta9es and duties reduces margins for downstream mar6eters and retailers (assuming t-at all additional ta9es cannot .e passed onto consumers!225 Lore importantly as t-e 11t- ;ive3+ear Plan ac6nowledges t-e ta9 system Jcreates a .usiness environment fraug-t wit- uncertainties anomalies and geograp-ic comple9itiesK22/ $ne of t-e 6ey components of regulatory reform under Policy &oal 1 in t-e 11t- ;ive3+ear Plan is to streamline simplify and standardise t-e petroleum product ta9 regime to ensure universal ta9 structures .etween Aurisdictions and products2 )-us far little progress -as .een made on t-is issue given t-e interest of states in protecting t-eir revenue raising autonomy2 (c! *egal environment4 Indias downstream legal framewor6 is e9tremely comple9 wit- a variety of often conflicting regulations still in place2 Indias court system in general is prone to lengt-y delays wit- most courts lum.ered wit- numerous unsettled dispute cases2 In ordinary cases foreign downstream investors -ave to manoeuvre t-roug- a myriad of rules and certifications to o.tain t-e estimated seventy separate approvals needed for setting up .usiness in India (unless it is operating wit-in a S(E or ($F!2@0 Leanw-ile delays in -earings and Audgements are routine2 )-ere is a perception wit-in t-e international .usiness community t-at in general India lac6s effective respect for t-e sanctity of contract2 Cowever t-ere are an increasing num.er of agreements t-at provide for ar.itration sucas t-roug- t-e International ,entre for 'lternative Dispute Resolution or in serious cases t-roug- multilateral conventions li6e t-e &eneva ,onvention2 )-e esta.lis-ment of t-e P%&RB in particular -as added a degree of certainty and oversig-t to downstream .usiness practice2 $n t-e w-ole t-e legal system governing Indias downstream sector is in a state of transition wit- t-e end goal of .eing more responsive to t-e needs of foreign .usinesses and t-e private sector2 ,urrently -owever several s-ortcomings primarily in terms of efficiency of procedure e9ist in t-e legal system2 @1
20
' standardised O') was introduced in India at t-e .eginning of ;+ 200?30I -owever almost -alf of Indias states at w-ic- level it is levied -ave simply refused to put t-is in place2 Lany ot-ers t-at -ave put it in place -ave reserved t-e rig-t to levy ot-er sales ta9es t-us undermining t-e .asic premise of a universal O')2 25Some states -ave Jirrecovera.le ta9esK on t-e sale of petroleum products meaning t-ese ta9es cannot .e passed on in t-e form of -ig-er prices2 Suc- ta9es are t-erefore levied on t-e revenues of t-e vendor from t-e sale of t-e product2 2/Planning ,ommission (2000! JPetroleum and %atural &as ,-apterK (levent- ;ive3+ear Plan2 @0Business Lonitor (200/! JIndia $il and &as Report V@ 200/K Dune p2 1@2 @1I.id2 p2 112
;ostering investment4 Special (conomic Eones (9port3$riented Fnits

In an effort to encourage investment in 6ey industrial sectors t-e &oI in partners-ip wit- state governments -as introduced cornerstone industry policy t-at see6s to esta.lis- S(Es and ($Fs2 #-ile somew-at different in nature .ot- S(Es and ($Fs are designed to4 (a! reduce t-e red3 tape associated wit- investing in India8 and (.! provide certain ta9 and income concessions for Page H 2@ .usinesses investing in 6ey e9port3oriented industries2 Petroleum product refining and processing is one of t-e sectors t-at are targeted .y t-e S(E and ($F programmes2 (a! Special (conomic Eones4 Indian S(Es are legally deemed foreign territory in order to s6irt Indias multiplicity of domestic duties and tariffs and its numerous controls and aut-orisations2 S(Es may .e esta.lis-ed eit-er .y state and central governments in colla.oration or .y corporations on re7uest to state and central governments2 )-e maAor condition amongst several ot-ers for t-e location of operations in a S(E or t-e .id to -ave a S(E designated around t-e location of operations is t-at companies must earn greater t-an I0N of revenues in foreign currency2 Because of t-e still3developing nature of refined product e9port in India downstream companies are currently active in only 1 S(Es out of a total of over @004 Langalore S(E &uAarat (i2e2 Damnagar! Cydrocar.on and (nergy S(E and Koc-i and Lundra Ports2 )-e 6ey incentives and facilities offered to investors wit-in S(Es are4 9 9 9 9 9 JSingle windowK clearance of investments and proAects for .ot- central and state government approvals controls and clearances2 Duty free import of goods for development operation and maintenance of S(E units2 100N income ta9 e9emption on companies e9port income for first five years and ?0N e9emption for t-e five years t-ereafter2 %o restriction on e9ternal commercial .orrowing up to FSD ?00 million in a year t-rougrecognised .an6ing c-annels2 (9emption from central government sales ta9 and service ta9 and e9emption from state government sales ta9 as well as various ot-er duties levied .y states2
(.! (9port3$riented Fnits4 ' corporation e9porting over 0?N of production is entitled to apply to .ecome an ($F a corporation3centric designation to complement geograp-y3centric S(Es (w-ic- often involve a num.er of companies!2 ($Fs receive many of t-e same .enefits as corporations located in S(Es sucas Jsingle3windowK investment and proAect clearance and income ta9 e9emption2 Lany ($Fs operate in S(Es2 Cowever t-e ($F designation is intended largely for corporations w-ose operations are geograp-ically spread and not concentrated in a small area2 Fnder t-e ($F sc-eme corporations are allowed to purc-ase all goods re7uired to produce e9ports free of all duties : e9cise customs duties states levies etc2 's -as .een mentioned RI*s massive II0 000 ..l=d Damnagar I refinery was esta.lis-ed as an ($F2 In early 200/ -owever RI* re7uested t-at t-e ($F designation .e removed2 )-is was a result of rapidly falling international product demand in t-e wa6e of t-e glo.al economic slowdown8 and falling crude prices w-ic- temporarily made domestic retail of sensitive petroleum products commercially via.le for RI*2 )-e move away from ($F status was t-erefore caused .y a com.ination of e9ternal events rat-er t-an a fundamental s-ift in t-e .usiness model for RI*s refining operations2
'ssessing Indias downstream sector regulatory framewor6

)-e regulatory framewor6 and .usiness environment in Indias downstream sector is evolving to increasingly cater to t-e needs of private3sector investors (e2g2 in t-e rela9ation of foreign investment controls! -owever t-ere remain considera.le wea6nesses2 's mentioned t-ese Page H 21 wea6nesses stem largely from t-e institutionalised red tape cluttering Indias legal regulatory and financial systems2 )-e esta.lis-ment of single3window proAect and investment clearance t-roug- S(E and ($Fs -as remedied t-is condition to some e9tent2 Cowever t-e very process of esta.lis-ing S(Es and ($Fs is itself 7uite comple9 e9pensive and time3consuming2 ;urt-er S(Es -ave in t-eir principle received a great deal of criticism in India and e9ternally4 9 ' concerted grass3roots movement .y various groups in India -as called loudly for a moratorium on t-e esta.lis-ment of new S(Es w-ic- effectively cede land away from India2 )-is -as placed t-e future of t-e S(E policy in dou.t2 )-e #orld Ban6 -as criticised t-e &oIs practice of locating S(Es in underdeveloped regions to foster development rat-er t-an in strategic trade facilitating locations2 'ccording to t-e #orld Ban6 even S(Es esta.lis-ed in coastal districts (sucas Damnagar! focus activity away from t-e coast itself in order to develop inland districts2@2 S(E and ($F programmes -ave .een censured for creating perverse incentives in Indian petroleum product mar6ets2 ,onducting .usiness as an ($F or wit-in a S(E (as RI*s Damnagar comple9 does! re7uires corporations to loo6 to e9port product as muc- as possi.le to meet t-e conditions of operation2 )-e situation currently e9ists t-erefore t-at $L,s are re7uired to import petroleum and diesel to meet domestic product demand (and pay customs duty on t-eses imports! w-ile t-ese same products are simultaneously e9ported .y private3sector refiners2
)o t-is e9tent it is increasingly necessary to reform t-e domestic regulatory environment as a w-ole rat-er t-an to rely on flawed Je9ceptionalistK e9port promoting policies and programmes2 )-is is li6ely to .e a painsta6ing and drawn3out process2 In t-e downstream sector -owever t-e &oI can ma6e a -andful of 6ey reforms t-at are li6ely to significantly improve t-e .usiness environment2 )-e esta.lis-ment of t-e P%&RB for an e9ample of sucstrategic reform -as provided investors wit- added legal certainty and more transparent regulatory oversig-t and ar.itration2 $f most pressing concern on t-is reform agenda mig-t .e t-e restructuring of t-e muddled system of ta9es duties and levies on petroleum products2 's promised in t-e 11t- ;ive3+ear Plan t-e &oI s-ould move .eyond scoping studies of downstream ta9 reform to concretely implement t-e unification of separated state product mar6ets to properly standardise t-e O') and to remove t-e multitude of state ta9 anomalies and e9ceptions2
)-is would of course -ave to .e underta6en in colla.oration wit- state governments : a significant underta6ing2 )a9 reform is crucial -owever to reduce w-at t-e Planning ,ommission calls Jt-e uncertainties and geograp-ic comple9itiesK faced .y investors in Indias downstream sector2 'not-er 6ey institutional pillar for well3functioning product mar6ets for e9ample is t-e esta.lis-ment of a petroleum product e9c-ange2 By su.stantially reducing transaction costs increasing competitiveness and efficiency and greatly augmenting mar6et transparency t-e creation of suc- a mar6et e9c-ange is a crucial step in esta.lis-ing t-e institutional .asis for India to .ecome a refined product trading -u.2
@2
#orld Ban6 (2005! #orld Development Report 200/ %ovem.er pp2 2@32?2
Indias regulatory framewor6 governing t-e downstream petroleum sector is in a state of transition2 ,urrently downstream investment in India is promoted less .y competitive advantages created .y t-e &oI and more .y t-e in-erent comparative advantages of t-e country itself2 Indias large and rapidly growing domestic petroleum product mar6et is wit- t-e similar emergence of ,-ina a per-aps unprecedented mar6et opportunity for t-e glo.al oil and petroleum industry2 India simultaneously .oasts low unit la.our costs and t-e demograp-ic Page H 2? potential for a large and capa.le s6illed=managerial wor6 force2 &eograp-ically Indias #est ,oast is strategically located directly facing t-e Persian &ulf across t-e 'ra.ian Sea from w-ere over 10N of t-e worlds sea.orne crude oil originates2 In addition t-e Liddle (asts refined product demand is growing rapidly2 )-e country is also strategically placed straddling 6ey glo.al crude producers in t-e Liddle (ast and t-e growing consumption centres of (ast3 and Sout-3 (ast 'sia2
#-ile t-e distinctive com.ination of Indias comparative advantages puts it in a reasona.le position to attract downstream private3sector investment t-e &oI nevert-eless needs to streamline t-e regulatory framewor6 governing t-e downstream sector to ma6e it more conducive and open to timely investment .y private3sector energy firms2 ,-apter ? will e9amine in more detail t-e potential for India to do so and to t-ere.y esta.lis- a glo.al li7uid fuels trading centre wit-in Indias .orders over t-e medium3term2 ,-apter 1 e9amines t-e patterns of growt- and investment in t-e $L, sector t-at ma6es up t-e great maAority of Indias downstream petroleum sector in terms of mar6et s-are refining capacity and investment2 's will .e discussed t-e dynamics of t-is sector -ave muc- more to do wit- t-e nature of government involvement wit- t-e 6ey companies t-an wit- domestic comparative and competitive advantages or rates of return on investment2
,-apter 12 Indias oil mar6eting companies

Indias pu.licly3owned $L,s are t-e dominant players in t-e countrys downstream petroleum sector2 In fact t-ey are among Indias top twenty largest corporations (.y sales! and eac- is a Page H 20 mem.er of t-e ;ortune ?00 list of t-e worlds ?00 largest companies2 Indias largest $L, : India $il ,orporation *imited (I$,*! : is t-e countrys largest corporate entity .y sales2 )-e great maAority of Indian consumers and industries especially t-e fertili"er and growing petroc-emical industries access petroleum products t-roug- t-ese $L,s2 It is impossi.le to understand dynamics wit-in Indias downstream petroleum sector t-erefore wit-out first understanding roles and operations of Indias t-ree $L,s wit-in t-is sector2 In t-e same way it is impossi.le to outline t-e potential future of t-e Indian downstream sector in t-e medium3 term wit-out understanding t-e prospects for $L, evolution and investment2
)-is c-apter provides an account of t-e nature and prospects of t-e $L, sector and its implications for t-e evolution of Indias downstream industry2 It concentrates in particular on t-e a.ility of $L,s to invest in refinery capacity at a sufficient rate to4 (a! ade7uately meet growing Indian demand8 and (.! to position India as a world3leading refined products e9porter into t-e future2 In order to outline product mar6et conditions ,-apter 2 confined analysis to Indias four most consumed and su.sidised petroleum products : petroleum diesel 6erosene and *P&2 Since t-is c-apter is concerned largely wit- refinery investments in general rat-er t-an pricing arrangements specifically t-is e9ception will not .e made -ere2
$L,s relations wit- t-e &oI

's well as .eing t-e dominant entities in Indias downstream sector $L,s are t-e 6ey lin6 .etween t-e petroleum industry and current government downstream policy especially pricing policy2 By supplying petroleum products at a set price $L,s are t-e tools of t-e &oIs li7uid fuels access policy2 's a result $L,s -ave .orne t-e full .urden of t-e &oIs control of product prices2 Importantly .y a.sor.ing t-e losses in-erent wit-in t-e current system of mar6et regulation $L,s define t-e remaining mar6et3space wit-in w-ic- ot-er downstream actors sucas private3sector refiners may operate and invest2 )-is c-apter see6s to outline t-e nature of t-is space2 $L,s are maAority3owned .y t-e &oI and formally come under t-e Aurisdiction of L%P&2 ;rom day3to3day t-ey are run in a corporatised and independent fas-ion according to nominally world3.est3practice commercial procedures and corporate governance standards2 )-e &oI -owever -as considera.le control over $L,s long3term strategy and investment programmes2 't t-e .eginning of every financial year $L,s sign a Lemorandum of Fnderstanding witL%P& w-ic- outlines agreed upon production and sales targets investment e9penditure plans and specific delegations of duties2 $L,s are also re7uired to su.mit investment plans to t-e Planning ,ommission for approval for eacof Indias 'nnual Plans as well as its ;ive3+ear Plans2 )-e Planning ,ommission retains some influence over t-e decisions made .y $L,s (9ecutive Boards -owever not to t-e same degree as LP%&2 )-roug- t-is process of consultation and approval t-e &oI is a.le to effectively control t-e nature and direction of $L,s commercial activities and investment e9penditures over time2 'n effective contract e9ists .etween t-e &oI and $L,s2 )-e &oI e9plicitly guarantees t-e solvency and commercial integrity of $L,s under all mar6et conditions2 $L,s in return (a! supply mar6ets at government3determined prices8
and (.! actively loo6 to invest to ensure refining retailing and infrastructure capacity meets rapidly growing Indian product demand2 ,-art I2 &oI sta6e in $L,s
Page H 25
/0 50 &overnment 00 $wners-ip (N! I0 ?0 10 @0 20 10 0 I$,* Source4 ,ompany ;inancial Statements2 BP,* CP,* I$,* BP,* CP,*
)-is guarantee -as come into play significantly in recent years2 In order for $L,s to not only remain solvent .ut to .e in a position to invest in additional capacity and infrastructure in a timely fas-ion t-e &oI -as needed to repeatedly J.ail3outK t-ese firms for t-eir losses under t-e current product pricing regime2 's will .e e9amined t-is e9plicit guarantee -as significant implications for t-e a.ility of $L,s to raise capital and invest over time and t-erefore for t-e evolution of Indias downstream industry as a w-ole over time2 #-ile $L,s (9ecutive Boards -ave fairly close ties to t-e &oI .ureaucracy t-ese companies -ave no formal role in policy ma6ing2 Disputes .etween $L,s and t-e government over policy (sucas t-e &oIs policy to .egin strictly managing product prices early in t-e last decade for e9ample! can .e acrimonious and long3lasting2
Structure of t-e $L, sector

Indias t-ree 6ey $L,s are (in order of si"e .y sales!4 9 9 9 Indian $il ,orporation *imited (I$,*!8 B-arat Petroleum ,orporation *imited (BP,*!8 and Cindustan Petroleum ,orporation *imited (CP,*!2
)-ese t-ree $L,s dominate t-e Indian downstream sector : .ot- in retail and (to a lesser e9tent! refining2 's ,-art 0 s-ows $L,s toget-er account for over ?0N of domestic refining capacity : and over 50N of t-is if RI*s single very large (and until recently e9port3oriented! Damnagar comple9 is e9cluded2 )-ey account for /5N of operational retail outlets2 #-ile RI* and (ssar -ave esta.lis-ed a retail presence in t-e Indian mar6et as mentioned a.ove t-ese outlets were closed as crude costs increased rapidly .eyond retail prices2 's crude prices fell s-arply in
t-e first -alf of 200/ .ot- (ssar and RI* .egan slowly re3opening retail outlets : -owever t-e rise in international crude prices since mid3200/ -as effectively -alted t-is process for t-e moment2@@ )a.le 12 LaAor downstream players
I$,* 122 15 110 BP,* 02I 5 @5/ CP,* 022? 5 ?@/ RI* 1221@1 500 (ssar 0222 1 200 Llore 022 0 ,-ennai 021/ 0
Page H 2/
Refining (m.=d! Retail outlets Source4 I(' analysis2
's s-own in )a.le 1 t-e t-ree 6ey $L,s s-are Indian refining and retail wit- a very small num.er of ot-er industry players2 )-ese include two ot-er small pu.licly3owned corporations2 Langalore Refinery and Petroc-emicals ,orporation *imited (LRP*! is $il and %atural &as ,orporation ($%&,!s downstream su.sidiary w-ic- operates a single (alt-oug- 7uite large! integrated refinery and petroc-emicals plant in Langalore2 ,-ennai Petroleum ,orporation *imited (,P,*! is a su.sidiary of I$,* and operates two small refineries in )amil %adu State as well as small petroleum product mar6eting operations in Sout-ern India2 ,-art 02 Refining mar6et s-are
Reliance @2N
I$,* @1N
(ssar Langalore IN ?N ,-ennai ?N
BP,* 1?N
CP,* IN
Source4 I(' analysis2
RI* and (ssar t-e current private3sector players .ot- -ave -ig-ly am.itious downstream e9pansion plans in refining w-ic- see6 to fundamentally c-ange t-e landscape of refining in India2 )-e mar6et s-are in refining of t-ese two private3sector operators -as increased rapidly and mar6edly especially wit- t-e commissioning in early3200/ of RI*s giant ?50 000 ..l=d e9pansion to its Damnagar comple9 in &uAarat w-ic- -as since .ecome t-e worlds largest refinery comple9 (wit- a capacity of 1221 ..l=d!2 (ssar operates a single 220 000 ..l=d refinery
@@
,-art 5 assumes RI* and (ssars retail mar6et s-are is nil as private3sector auto fuels retail is via.le under current government pricing conditions only if world crude prices remain .etween FSD ??3I0=..l2 @1)-is figure includes Damnagar II commissioned in late320052 RI*s weig-t in Indian refining is somew-at overstated .y a simplistic comparison of refinery capacity4 RI* still operates only one (al.eit very large! refinery a significant proportion of w-ose product is e9ported2
at Oadinar very close to Damnagar in &uAarat wit- plans to increase refining capacity to I50 000 ..l=d .y 20122 )-ese two firms investments will .e e9amined in more detail in t-e following c-apter on international refining in India2 ,-art 52 Retail mar6et s-are Page H @0
CP,* 21N I$,* ?2N BP,* 21N
Source4 I(' analysis2
#it- e9tensive domestic mar6eting and retail networ6s and a government3determined function to meet growing domestic petroleum product demand $L,s operations are overw-elmingly centred on supplying t-e Indian mar6et2 (ac- currently e9ports on average as little as ?0 000 ..l=d of product (from total $L, refining capacity of a.out 2 million ..l=d!2 In contrast RI* and (ssars refining operations are designed to supply .ot- international and domestic product mar6ets2 Recent data indicate t-at .ot- private3sector refineries in &uAarat are currently producing an even .alance of output supplying t-e Indian mar6et and t-at destined for e9port2 It s-ould .e stressed t-at despite price controls RI* and (ssar are a.le to supply Indian mar6ets (eit-er domestic retail mar6ets or $L,s esta.lis-ed .ase of customers for industrial fuels and lu.ricants! .y selling refined products w-olesale to $L,s from t-e refinery gate2 Domestic refinery3gate prices are determined on a trade3parity .asis2 Private3sector refiners can t-erefore freely supply t-e Indian auto fuels retail mar6et t-roug- $L,s w-ile gaining mar6et3.ased refining margins and wit-out under3recovery2 By a.sor.ing t-e commercial losses in-erent in t-e current retail system $L,s t-erefore create a space in Indian product mar6ets in w-ic- t-e private3sector can conduct commercially via.le profita.le and sustaina.le .usiness despite t-e e9istence of price controls2
' .rief description of Indias t-ree $L,s

(a! Indian $il4 I$,* is t-e giant of Indias -ydrocar.ons industry2 Its refining and retail operations are t-e focus of I$,*s .usiness alt-ougit maintains -ig-ly diversified commercial operations including significant upstream (9ploration and Production ((PP! (in India as well as internationally! and petroc-emicals and fertili"er .usinesses2 I$,*s large
si"e and diversified operations -ave meant t-at it -as weat-ered t-e &oIs product pricing policies somew-at .etter t-an t-e smaller $L,s2 In t-e downstream sector I$,* -as over ?0N mar6et s-are in mar6eting and retail2 It also -as an impressive portfolio of refineries ma6ing up a.out @2N of Indian refinery capacity2 I$,* operates 10 refineries across India wit- a com.ined capacity of a.out 122 million ..l=d2 (.! B-arat Petroleum ,ompany4 BP,* is Indias second largest $L, .y sales marginally larger t-an Cindustan Petroleum ,orporation and appro9imately t-e @00t- largest corporation in t-e world2 's s-own in )a.le 1 BP,* operates a retail networ6 of over 5 000 outlets : t-e smallest retail presence of t-e maAor $L,s2 ,ompared to its small automotive fuel retailing operations -owever BP,* -as large industrial and Aet fuel mar6eting operations2 )-is is advantageous for BP,* as Aet fuel and ot-er industrial products fall outside t-e &oIs price controls2 BP,* maintains t-ree refineries4 its @00 000 ..l=d Lum.ai refinery8 t-e 1?0 000 ..l=d %umarlingar- refinery in %ort-3(astern India8 and t-e 1?0 000 ..l=d Koc-i refinery in Sout-ern India2 Page H @1
(c! Cindustan Petroleum ,orporation4 CP,* is t-e smallest of Indias t-ree 6ey $L,s alt-ougit is still one of t-e fifteen largest corporate entities in India2 CP,* -as a slig-tly greater auto fuels retail presence t-an BP,* : also wit- over 5 000 retail outlets2 Its large e9posure to t-e auto fuels retail mar6et -as meant CP,* -as .een significantly affected .y price controls2 CP,*s refining capacity is significantly less t-an .ot- I$,* and BP,*2 It operates two refineries : one located in Lum.ai and one at Oisa6- on t-e (ast ,oast wit- capacities of 120 000 ..l=d and 2@0 000 ..l=d respectively2 CP,*Ws production capacity at t-ese two refineries -as e9panded steadily t-roug- a num.er of recent capacity e9pansion proAects2 )-e companys Lum.ai refinery is distinctive as a lu.e3specialist refinery wit- Indias -ig-est lu.e production capacity conferring CP,* a dominant mar6et s-are in t-is unregulated product segment2
)-e c-allenge facing $L,s

Indian demand for petroleum products is growing rapidly2 ,lose to one million cars were sold per mont- in India in 200/2 In 2005 Indian product demand was appro9imately 22/ m.=d2 Demand is e9pected to grow at up to 1N per year in t-e following years : meaning in t-e five years to 2011 demand is forecast to approac- @20 m.=d an increase in demand of 500 000 ..l=d2@? )-e significant c-allenge facing $L,s is to add refinery capacity to meet t-is strongly growing domestic demand2 't t-e same time $L,s -ave a commercial and government3driven (alt-oug- secondary! imperative to e9pand petroleum product e9port capacity2 )-ese two commercial o.ligations re7uire significant large3scale investment in capacity .y $L,s currently and into t-e future2 $L,s are -owever under significant financial strain as a result of t-e &oIs retail pricing policies8 in fact t-ey remain effectively insolvent2 )-e 6ey 7uestion t-erefore is4 to w-at e9tent can $L,s ac-ieve t-e capacity e9pansion necessary to meet growing demand given t-eir current commercial positions2 )-is 7uestion will .e e9amined in detail .elow2
@?
See (I' (200/! India ,ountry Report p2 12
,-art /2 Indian product demand
Page H @2
@2?
B.l=d @
200/32011 proAected
22?
200020012002200@2001200?200I20002005200/20102011 2012201@2011 Source4 I(' Ledium3)erm $il Lar6et Report (L)$LR!2
$L,s financial performance

's a result of retail pricing controls t-e $L, sector as a w-ole performed very poorly from a financial perspective in ;+ 200530/2 )a.le 2 lists t-e 6ey financial indicators for eacof Indias t-ree $L,s from ;+ 2000305 to ;+ 200530/2 In general it tells a worrying story2 's )a.le 2 s-ows unsustaina.ly wea6 cas-flows were a significant issue for $L,s wit- .ot- I$,* and CP,* recording negative operating cas-flows (and BP,* recording negative net cas-flows! in ;+ 200530/2 )-e financial position of eac- $L, is e9amined in more detail .elow2
I$,*
)-e relative -ealt- of I$,*s .alance3s-eet (compared to smaller $L,s! is apparent w-en comparing gross operating margins2 In ;+ 200530/ I$,* ac-ieved gross operating margins around ?0N2 )-ese are -igcompared to glo.al industry averages and e9tremely -igcompared to t-e gross margins of Indias ot-er $L,s2 #orryingly -owever net cas-flow for ;+ 200530/ is almost "ero2 In fact net cas-flow figures reflect a gross operating cas-flow of negative FSD 120 .illion2 )-is entirely unsustaina.le situation is not altoget-er surprising given pricing arrangements2 Indeed over t-e course of ;+ 200530/ I$,* received appro9imately FSD 5 .illion from t-e &oI in oil .onds specifically to counteract t-e cas-flow pro.lems resulting from controlled prices2 )-e &oIs significant support for I$,* in 200530/ -as successfully .olstered t-e companys .alance3s-eet and left it well3placed for furt-er e9pansion2 I$,* is un.urdened .y large amounts of de.t2 Its de.t3to3e7uity ratio is -ealt-y at Aust greater t-an one2 I$,*s interest payment .urden -owever -as increased precipitously in t-e last year2 In ;+ 200530/ I$,*s profit covered total interest payments .y a magnitude of a.out t-ree compared to a magnitude of greater t-an nine in ;+ 20003052
)a.le 22 $L,s 6ey financial indicators

De.t :e7uity @Iratio Interest coverage @0ratio 2005 30/ 225 12/ 220 2000 305 /2@ I2@ 120 Profit after ta9 (FSD .n! 2005 30/ 02I 021? 021 2000 305 122 02@ 02@ $perating cas-flow @5(FSD .n! 2005 30/ 3120 122 122 2000 305 3220 021 302@ %et cas-flow @/(FSD .n! &ross margin 10(N!
2005 30/ I$,* BP,* CP,* 122 125 @21
2000 305 120 121 120
2005 30/ 020 3120 021
2000 305 020 302I 022
2005 30/ 15 /20 3120
2000 305 1I 520 120
Page H @@
BP,*
#it- less diversified operations t-an I$,* BP,* -as fared .adly recently2 In ;+ 200530/ BP,*s gross operating margin was .elow 10N compared to a glo.al industry average of close to 10N2 %ot surprisingly net cas-flow was negative FSD 122 .illion in ;+ 200530/ furt-er down from around negative FSD 000 million in ;+ 20003052 ,onsistent and -eavily negative net cas-flow means BP,* -as failed to generate necessary operating revenue over time2 )-e provision of FSD @22 .illion in oil .onds from t-e &oI (e7uivalent to over 12N of total sales! -owever -elped BP,* to post a small profit in ;+ 200530/2 )-is profit was almost entirely a.sor.ed .y interest payments on accumulated de.t2 Ceavily negative net cas-flow also means t-at BP,* -as .een forced to rely on de.t financing for investment2 In ;+ 200530/ de.t3to3e7uity was almost dou.le t-e levels considered to .e optimal2 's mentioned BP,*s growing inde.tedness -as meant its wea6 yearly profits are used almost entirely to cover its growing interest .urden wit- t-e companys interest coverage ratio falling to .elow 12/2
@I
)-is ratio gives an indication of a corporations inde.tedness : and t-ere.y (a! its interest .urden and (.! its a.ility to raise furt-er de.t capital for investment : .y comparing accumulated de.t and e7uity at t-e end of any given financial year2 Ratios of around 1 are considered optimal w-ile t-ose X1 are considered ris6y2 @0)-is ratio is a measure of a companyWs a.ility to -onour its de.t payments2 It compares a companys profit wit- its interest .urden2 #-en profit3interest is less t-an 22? companies are at -ig- ris62 Ratios Y1 indicate t-at a company will not generate enoug- cas- to meet its interest o.ligations2 @5$perating cas-flow refers to t-e amount of cas- a company generates from t-e revenues from core operations e9cluding net revenues from long3term investment on capital items investment in securities or cas- transfers2 @/%et cas-flow refers to total cas- generated .y a company from all activities including operating cas-flow8 revenue received from t-e sale of long3life assets8 capital e9penditure8 or cas- received from t-e issue of de.t and e7uity or paid out as dividends2 10&ross margin is t-e relations-ip .etween a companys profit and its sales revenue similar to its mar63 up2 It calculates t-e proportion of sales revenue t-at is profit2 &ross margins of @0N are considered -ealt-y2
,-art 102 $il .ond issuance
/ 5 $il Bond values (Billions 0 FSQ! I ? 1 @ 2 1 0 I$,* Source4 ,ompany ;inancial Statements2 BP,* CP,* 200032005 20053200/
Page H @1
CP,*
CP,*s relatively undiversified refining and retail .usiness -as also fared .adly in recent years2 In ;+ 200530/ CP,* maintained a negative gross operating margin a rare and unsustaina.le situation and a direct conse7uence of t-e &oIs product pricing policies2 Fnli6e I$,* and BP,* CP,*s net cas-flow from all activities in ;+ 200530/ was marginally positive (as a result of its sale of assets!2 CP,*s de.t .urden -as increased mar6edly in recent years2 )-e companys de.t3to3e7uity ratio -as increased to more t-an triple t-e level considered optimal w-ile t-e a.ility of CP,*s current profit to cover interest payment o.ligations -alved from 2000 to 20052 $il .onds issued to CP,* .y t-e &oI in ;+ 200530/ amounted to close to FSD @ .illion2
$L,s investment programmes

Despite t-eir dire financial performance $L,s -ave developed financed and are implementing am.itious capital investment programmes in distri.ution and retail infrastructure and importantly in considera.le additional refining capacity2 )-e &oIs demonstrated willingness to .ac6 $L,s as instruments of pu.lic policy com.ined wit- its support for $L,s finances t-roug- t-e issuance of oil .onds -ave provided t-ese firms wit- a great deal of leverage w-en raising capital in de.t and e7uity mar6ets2 ;urt-er it -as provided $L,s wit- a level of operational and commercial fle9i.ility in w-ic- s-ort3term rates of return on investment are not entirely compelling2 's will .e s-own t-e $L, sector is t-erefore defined .y -eavy3-anded regulation and poor commercial performance yet ro.ust investment capacity addition and growt-2 )-e investment programme of eac- $L, is e9amined in turn .elow wit- a focus on refinery capacity additions2 )-e implications of t-e current situation are also analysed in t-is c-apter2
I$,*
I$,* -as formulated a massive downstream investment and e9pansion programme to strengt-en its core .usiness and allow for rapidly growing product demand in India2 Its relatively de.t3free .alance s-eet and t-e continued .ac6ing of t-e &oI are 6ey in t-is regard2 In 200530/ I$,*s investment e9penditure totalled FSD 2221 .illion including appro9imately FSD 122 .illion Page H @? on refinery capacity e9pansion and yield and 7uality improvements and mar6eting operations2 )-is compares to profit after ta9 of FSD /00 million in t-e same year2 Fnder its medium3term investment strategy to Larc- 2012 I$,* plans to invest FSD /221 .illion2 )-is includes FSD ?21 .illion on refinery capacity e9pansions meaning close to I0N of I$,*s total planned investment e9penditure .udget is dedicated to refining2 I$,*s maAor downstream investment proAects include4 9
)-e construction of a large state3of3t-e3art greenfield @00 000 ..l=d refinery at Paradip in (astern India wit- a total cost of FSD 1 .illion2 )-e proAect aims to meet t-e current deficit of lig-t3middle distillates in (astern India and is sc-eduled to .e completed .y late320122 I$,*s Panipat refinery in Caryana is .eing e9panded .y I0 000 ..l=d to meet t-e growing product deficit in t-e -ig-3demand %ort-3#est region of India wit- a cost of FSD @00 million2 ' long3distance pipeline lin6ing t-e Panipat refinery wit- Lundra port in &uAarat State is also part of t-is proAect2 I$,* is investing -eavily in petroleum 7uality upgrade proAects at its &uAarat #est Bengal Caryana Bi-ar and 'ssam refineries to ensure eacof t-ese facilities produces at least (uroIO fuel 7uality grades .y 2011211 )-ese upgrades will come at a total cost of a.out FSD 221 .illion2
BP,*
Despite t-e fragile state of its .alance s-eet BP,* is nevert-eless e9panding capacity to meet growing demand and en-ance its mar6et s-are (especially in automotive fuels! t-roug- a compre-ensive investment programme2 )-is investment programme is only possi.le t-rougt-e continued financial support and e9plicit .ac6ing of t-e &oI2 #it- -ig- levels of de.t a growing interest .urden wea6 profits and negative net cas- flows BP,* on t-e strengt- of its .alance s-eet would li6ely .e una.le to raise t-e significant capital necessary for large3scale and ongoing capacity e9pansions2 )-e regular e9tensions of oil .onds to BP,* (amounting to close to FSD ? .illion since 2000! not only smoot-3over maAor cas-flow issues .olster t-e companys .alance s-eet and ensure BP,* can service its de.t in t-e s-ort3term t-ey also create confidence wit-in financial mar6ets t-at BP,* will remain commercially via.le over time2
't t-e centre of BP,*s investment programme is t-e greenfield construction of its Bina refinery comple9 in ,entral India : a Aoint venture .etween BP,* and $man $il ,ompany2 )-e Bina comple9 will -ave a capacity of 1@0 000 ..l=d and is sc-eduled for completion in 20112 'lso under construction are crude receipt and dispatc- facilities on t-e coast at Damnagar and a /@?36ilometre cross3country crude pipeline from Damnagar to Bina2 BP,* -as invested a total of
11
's mentioned a.ove t-e &oI -as mandated t-e sale of (uropean (missions Standards (uroIO fuels in ur.an areas and (uroIII fuels in rural areas .y 20103112 In (urope (uroIII was p-ased out in 200? w-ile (uroIO was p-ased out in 200530/2 ,learly $L,s refineries currently .eing upgraded to produce (uroIII=IO are some way .e-ind complete e9port readiness2 'll $L,s greenfield refineries currently under construction -owever are .eing .uilt to produce world3leading clean fuels2
over FSD 122 .illion in t-e Bina proAect2 BP,* is also underta6ing a FSD 1 .illion upgrade of its Koc-i refinery to .e completed in 20112 )-is proAect will add around ?0 000 ..l=d of capacity as well as upgrade product 7ualities to (uroIO standard2 's a part of t-e upgrade BP,* is investing to upgrade pu.licly3owned Koc-i port to allow mooring of Oery *arge ,rude ,arriers and to esta.lis- an undersea pipeline lin6 to t-e refinery as well as t-e addition of significant Page H @I e9tra crude and product storage capacity2 BP,*s Lum.ai refinery is also undergoing a compre-ensive upgrade to increase efficiency and fuel 7ualities -owever no significant new capacity will .e added2 ;inally all refineries will .e upgraded .y mid32011 to allow t-e production of at least (uroIII fuel grades2 BP,* -as t-erefore .een capa.le of significant investment in spite of persistently very wea6 commercial fundamentals2 #it- t-e currently proposed Stage II of its Koc-i refinery upgrade t-e company will -ave almost dou.led its 2005 refining capacity t-roug- various investments and e9pansions costing close to FSD ? .illion2
CP,*
CP,* -as a slig-tly less am.itious investment programme t-an eit-er I$,* or BP,*2 %evert-eless investment e9penditure remains decidedly e9pansionary to capitalise on growing Indian product demand2 )-e centrepiece of CP,*s investment e9penditure is t-e construction of t-e &uru &o.ind refinery at B-atinda in PunAa. province : wit- an initial capacity of almost 200 000 ..l=d and costing appro9imately FSD @ .illion2 )-e refinery is a Aoint venture .etween CP,* and Littal (nergy Investments : a su.sidiary of t-e *2%2 Littal &roup of companies : witeac- partner ta6ing a ?0N sta6e in t-e venture2 ' /0036ilometre pipeline from Lundra Port to t-e refinery at B-atinda will also .e .uilt as part of t-e proAect2 )-e proAect is sc-eduled for completion in 2012 and will almost dou.le CP,*s current refining capacity2 &uru &o.ind is intended to ease product availa.ility in t-e companys growing mar6eting networ6 in Indias fast3growing %ort-ern regions2 In order to ease product tig-tness in diesel and Aet fuel CP,* is increasing distillate production .y close to I0 000 ..l=d across its refineries at a total cost of FSD I00 million2 Bot- currently operational refineries are .eing upgraded to allow t-e production of (uroIO auto fuels2
'ssessing $L,s4 do $L,s provide for growt- in Indias downstream sectorM

)-e foregoing analysis of Indias $L,s paints a mi9ed .ut e9tremely interesting picture2 $L,s -ave clearly suffered considera.ly at t-e -ands of t-e government3imposed restrictions on retail prices2 ;or eac- operating cas-flows in 200530/ were negative and significant government support was re7uired to merely 6eep t-em solvent and marginally profita.le2 Received wisdom would suggest t-at wit- $L,s commercial imperatives and revenue earning potential undermined .y -eavy3-anded mar6et regulation t-e a.ility of companies to underta6e timely large3scale investment to meet rapidly growing domestic demand would .e t-oroug-ly undermined2 #it- dried3up cas- flows and managed end3user prices t-e incentive for investment it may also .e argued is removed2 )-is as s-own is not t-e case : somet-ing w-icis clear w-en t-e $L, sector is analysed as a w-ole2 Despite decidedly wea6 commercial performance and poor .alance s-eet fundamentals $L,s -ave toget-er put in place e9pansive investment programmes t-at loo6 li6ely to more
t-an cater for ro.ust Indian petroleum product demand growt- in t-e medium3term2 It may .e concluded t-erefore t-at t-e $L, sector is defined .y -eavy3-anded regulation and poor core commercial performance yet ro.ust investment capacity addition and growt-2 Indian product demand is e9pected to grow from an e9pected total of @ million ..l=d in 200/ .y appro9imately 000 000 to @20 million ..l=d in t-e five years to 20112 $L,s will add a.out I00 000 ..l=d of additional capacity in greenfield refinery proAects alone .y 20122 )-is does not Page H @0 include (a! $L,s e9tensive .rownfield capacity e9pansions and upgrades t-at are descri.ed a.ove8 (.! t-e am.itious investment plans of private3sector refiners8 or (c! e9isting surplus refinery capacity w-ic- -as emerged since t-e start3up of RI*s Damnagar II refinery in early 200/2 &iven t-at in t-e $L, sector product t-at is surplus to t-e demands of t-e domestic mar6et is e9ported internationally growing $L, refining capacity .odes well for Indias goal to develop into a maAor e9porter of petroleum products2 In fact $L,s uni7ue relations-ip wit- t-e &oI -as dramatically en-anced rat-er t-an -indered t-e investing potential of t-ese companies and t-erefore t-e dynamic growt- of Indias downstream petroleum sector2 )-e e9plicit guarantee .y t-e &oI t-at $L,s will .e 6ept solvent and profita.le over time lends $L,s -uge advantages w-en raising capital for investment in financial mar6ets2 Potential financiers may .e certain t-at despite w-at may .e -ig- levels of corporate de.t and wea6 profits government support will ensure t-at $L,s de.t and interest o.ligations are met2 )-is is clear in t-e corporate credit ratings of $L,s2 Despite very wea6 financial fundamentals I$,* BP,* and CP,* were eac- awarded a ''' credit rating .y SPP (t-roug- its Indian su.sidiary ,RISI*! in 200/ .ecause Jt-e pu.lic policy role performed Z.y $L,s[ ma6es it .inding t-at t-e government of India support t-e company and its sta6e-olders including lendersK212
Per-aps most significantly t-e willingness of t-e &oI to consistently J.ail3outK $L,s in return for relia.le mar6et supply and strong investment inevita.ly .reeds a soft investment constraint for t-ese firms2 #it- t-e government standing ready to a.sor. t-eir losses concerns of t-e rate3of3return of various investments are far less compelling for $L,s t-an for truly commercial actors a situation w-ic- typically results in t-e rapid investment (or potentially overinvestment! t-at -as .een witnessed in t-e last decade2 ;rom a policy outcomes perspective t-e current system of inter3relations .etween t-e &oI $L,s and product mar6ets is -ig-ly successful2 #it- $L,s assistance t-e Indian government -as .een a.le to pursue its official policy of providing afforda.le energy for Indias developmental needs and its significant poor population2 't t-e same time .y a.sor.ing $L,s losses under t-is system and e9plicitly guaranteeing t-eir operations capital financing and investments t-e government -as created an investment climate for $L,s w-ic- -as resulted in ro.ust sectoral capacity e9pansion and growt-2 )-e 6ey issue surrounding t-e $L, sector is t-erefore not one of lac6lustre commercial operations in an environment of -eavy3-anded regulation and price manipulation2 In fact one may conclude t-at t-e current system -as provided for a great deal of sectoral dynamism2 Instead it is a fiscal 7uestion2 ;or -ow long can t-e Indian government continue to spend -undreds of .illions of Indian Rupees on perpetuating t-e solvency and investing potency of $L,s t-at is re7uired under current product pricing arrangementsM
12
See for e9ample ,RISI* (2010! Cindustan Petroleum ,orporation *imited4 De.t Instruments and Ban6 ;acilities Danuary2
Pu.lic3 versus private3sector refining

#it- strong investment e9penditure as a result of relatively easy access credit and soft investment constraints and $L,s refining capacity e9panding rapidly it is important to assess t-e relative merits of $L,s massive recent investment drive2 #-ile downstream capacity from Page H @5 refining t-roug- to retail needs to 6eep pace wit- rapidly growing Indian (and to a lesser e9tent regional! product demand is t-is demand not .etter (and more efficiently! met t-rougprivate3sector investmentM ,learly t-e &oI -as decided t-at putting in place sufficient domestic downstream capacity is too important to leave to uncontrolled mar6et forces and t-e private sector2 It is unli6ely t-at t-is policy will lead to greatly poorer outcomes in terms of cost effectiveness service relia.ility and product delivery for Indias consumers2 $L,s -ave proven t-emselves to .e largely dependa.le and innovative operators and t-ere remains a great deal of .eneficial competition .etween eacof t-e $L,s as well as wit- private3sector firms2 'gain t-e issue is largely a fiscal one4 is t-e &oI willing to continue to support $L,s necessarily large capital e9penditures at t-e current level given innumera.le competing developmental priorities and t-e current fragility of its .udgetM If not policy ma6ers will need to .e certain t-at t-e private sector is willing and a.le to fill t-e investment JgapK created .y decreasing government support for $L,s2 In t-is case t-e &oI will need to ma6e concerted efforts to ensure t-e downstream .usiness environment is increasingly conducive to large3scale private investment2 )-ese issues will .e e9amined in ,-apter I2
Is $L, investment Jcrowding outK private3sector downstream investment in IndiaM )-e answer to some e9tent is yes2 *arge and fast3growing $L, refinery capacity inevita.ly diminis-es t-e potential mar6et s-are for private corporations2 ,urrently -owever t-e private sector is limited in t-e operations it can profita.ly conduct in Indias downstream sector given product price controls2 ;urt-er proportionally greater involvement in Indias downstream sector .y private firms is not li6ely to considera.ly affect t-e level of product delivery or service 7uality provided to Indian consumers2 In fact private3sector refiners are often operating in a slig-tly different mar6et segment to $L,s2 $L,s are a.ove all tas6ed wit- and focussed on serving Indias domestic mar6et2 #-ile t-e rapidly growing Indian li7uid fuels mar6et is an attractive commercial prospect private3 sector refineries -ave .een esta.lis-ed largely to produce e9ports destined for %ort- 'tlantic Liddle (ast and (ast3'sian e9port mar6ets w-ere refinery investment -as lagged demand growt- and structural product mar6et tig-tness persists2 &iven t-ese two largely separate .usiness models and mar6ets e9panding pu.licly3owned and domestically focussed refinery capacity will not altoget-er Jcrowd outK private3sector investment in Indias downstream sector2 's will .e e9amined in t-e following c-apter due to a num.er of forces private3sector refinery investment in India -as .een very strong in recent years and is forecast to remain ro.ust in t-e medium term2 In fact ,-apter ? argues t-at as a result of remar6a.ly strong investment .y private3sector refiners as well as $L,s in spite of o.structive pricing policy India is li6ely to emerge as 'sias largest refined product e9porter .y 20122
,-apter ?2 #ill India emerge as a maAor glo.al refined product e9porting -u.M
Page H @/ 's set out in its 11t- ;ive3+ear Plan t-e &oI see6s to esta.lis- India as a glo.al refined product e9porting -u. .ot- .y instructing $L,s to ta6e a more outward3oriented operating stance and .y encouraging private3sector refiners to invest in e9port3oriented refining capacity2 )-is c-apter will e9amine t-e e9tent to w-ic- India is li6ely to realise t-is internationally3significant policy and commercial goal in t-e medium3term2 )-e measure of Indias refined product e9port capacity over time will .e t-e .uild3up of e9cess refinery capacity over domestic demand21@ In fact Indias actual refined product e9port volumes are li6ely to .e larger t-an t-e aggregate of e9cess capacity2 $L,s loo6 to first supply t-e Indian mar6et and t-en to e9port t-e .alance of refined product produced2 Private3sector refiners -owever -ave no operational directive to first supply domestic mar6ets2 )-ey will loo6 to produce a product slate w-ic- optimises total refining margins from period3to3period and will sell to customers irrespective of location to allow t-is2 (9port mar6ets are t-erefore not a J.alanceK option for private3sector refiners .ut integral to t-eir .usiness model2 )-ere is t-us t-e possi.ility of a situation in India of large e9ports of refined products in parallel wit- product imports to satisfy domestic demand2 In t-e conte9t of sectoral e9pansion to facilitate greater e9port potential -owever e9cess refinery capacity is nevert-eless a valid measure of Indias growing e9porting potential2
)-e emergence of India as a glo.al refined product e9porting -u. is li6ely to -ave significant implications for regional product mar6ets e9tending t-e dept- of product mar6ets in t-e Liddle (ast and Sout-3east 'sia in particular2 It is also li6ely to -ave competitive effects for esta.lis-ed 'sian refinery centres sucas Dapan Sout- Korea and Singapore and even as far afield as t-e Fnited States &ulf ,oast and %ort-3#estern (urope211 &rowing e9ports of refined product from India -ave t-e potential to add to t-e energy security of countries in t-e Liddle (ast and 'sia3Pacific t-at are increasingly reliant on refined product imports sucas Iran Saudi 'ra.ia Oietnam Indonesia and 'ustralia2 But at t-e same time t-ey t-reaten to undermine competing (and often ageing! refineries in countries sucas Dapan Sout- Korea and 'ustralia2 )-is c-apter loo6s primarily at t-e period to 2012 w-en t-e last of t-e current spate of refinery capacity additions in India will .e completed2 %o large greenfield or .rownfield refinery additions -ave .een firmly proposed for start3up after 2012 given all proAects finis- to current proAect timelines2 Several smaller e9pansion and upgrading proAects are planned .y RI* and eacof Indias $L,s to 201?2 &iven t-e lac6 of 6nown firm investment plans it is unli6ely t-ere would .e any maAor capacity additions in India .etween 2012 and 201? despite t-e .rea6nec6 speed in w-ic- Indian proAects are completed2 ;urt-er it is difficult to anticipate policy settings for t-e period after 2012 : w-ic- impact directly on investment : until t-e release of t-e
1@
$f course in order for India to emerge as a truly world3significant refining -u. it will .e necessary to esta.lis- (t-roug- a com.ination of private3 and pu.lic3sector investment! t-e 6ey institutions and infrastructure re7uired for t-e wor6ings of suc- a -u. (road freig-t infrastructure ports mass3-andling facilities pipelines etc!2 Description of investment dynamics in t-ese fields is .eyond t-e scope of t-is report : it is assumed t-at investment in infrastructure and institutions lags .e-ind refinery capacity investments2 11See ;',)S (200/! 'sia3Pacific $il Product Balances $il Data.oo6 II p2 22
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 12t- ;ive3+ear Plan in 20112 'nalysis .elow t-erefore confines itself to t-e medium3term : focussing on t-e period to 2012 .ut also loo6ing a-ead to 201?2 )-ere is more data availa.le on regional refinery capacity addition post320122 ;or e9ample significant refining capacity (over 2 m.=d! is sc-eduled to come on3line across t-e Liddle (ast after 2011 particularly in Saudi 'ra.ia Kuwait and Iran2 Page H 10
Demand growt- in 'sia3Pacific and t-e Liddle (ast

)-e commercial and policy impetus to esta.lis- India as maAor refined product e9porter a.ove all stems from strong medium3 and long3term demand growt- forecast in t-e 'sia3Pacific and Liddle (ast regions and t-e gradual esta.lis-ment of 'sia as t-e 6ey emerging pole of international li7uid fuel demand2 'ccording to t-e I('s 2005 #orld (nergy $utloo6 close to 5?N incremental oil demand to 20@0 will come from 'sia3Pacific and t-e Liddle (ast21? #-ile t-e glo.al recession slowed t-e pace of economic growt- non3$(,D 'sia and t-e Liddle (ast are still e9pected to post strongly positive growt- in 200/310 and return to -ig- levels of growtafter 20112 In t-e five years to 2011 petroleum product demand growt- in 'sia (e9cluding ,-ina Sout- Korea and Dapan! and t-e Liddle (ast is forecast to rise .y a.out 1N per annum2 ,-inas product demand is e9pected to grow .y an average of 12?N per annum to 20112 's recognised .y .ot- Indian policy ma6ers and .y private industry t-ere is t-us significant opportunity to leverage Indias commercial and geograp-ic comparative advantages to esta.lisrefinery operations t-at supply a s-are of t-is rapid e9pansion in regional li7uid fuels demand2
,-art 112 Strong 'sian product demand growt-
11 10 Product / Demand (m.=!d 5 0 I ? 1 @ 2 200/ 2010 2011 2012 201@ 2011 ,-ina India Liddle (ast
Source4 I(' Ledium3)erm $il Lar6et Report (L)$LR!2
It is not only 'sian mar6ets t-at Indian refined product e9ports are intended to penetrate2 RI* for e9ample planned to send up to @0N of total e9port spot cargoes (a.out 0?N of e9ports! from Damnagar II to t-e Fnited States .efore t-e onset of t-e current glo.al recession and leased significant product storage space in %ew +or6 Car.our in 20052 In order to supply %ort'tlantic mar6ets (w-ere no greenfield refinery -as .een constructed in 2? years! RI* and (ssars
1?
I(' (2005! #orld (nergy $utloo6 pp2 I23I?2
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 e9isting refineries are configured to produce (uroO 7uality fuels2 1I In t-e same way all greenfield $L, refining capacity is re7uired .y t-e &oI to meet t-e most stringent glo.al fuel 7uality standards so t-at product can .e readily e9ported if necessary to t-e Fnited States (urope Dapan and 'ustralia2 Indeed t-e large si"e comple9ity and modernity of Indias new refining comple9es put t-em at significant advantage to t-e smaller and older refineries in t-e esta.lis-ed mar6ets of (urope and %ort- 'merica2 'ccording to t-e I('s 200/ Ledium3)erm Page H 11 $il Lar6et Report for e9ample more t-an 2 m.=d of refining capacity in (urope is under t-reat of permanent closure due to competition from new c-eap large3scale and comple9 refining proAects in developing 'sia and t-e Liddle (ast210
Ledium3term refinery capacity addition in India

Put simply India will -ave undergone little less t-an a revolution in domestic refinery capacity addition sop-istication orientation and glo.al importance in t-e years of t-e 11t- ;ive3+ear Plan2 ,-arts 12 and 1@ depict t-e .rownfield and greenfield refinery additions occurring in India to 2012 some of w-ic- were reviewed in t-e previous c-apter2 ;rom a current refining .ase of @2?1 m.=d India will increase refining capacity to close to ? m.=d .y around 2012 a -uge increase of over 10N in t-ree years2 $L,s will collectively add I00 000 ..l=d in greenfield refinery investment spread over t-ree different proAects2 )-is for e9ample is greater t-an t-e entire accumulated refining capacity of Lalaysia2 Private3sector firms will add Aust over ?00 000 ..l=d in greenfield investment led .y t-e 100 000 ..l=d P-ase II of (ssars Oadinar refinery (and assuming t-is proAect goes a-ead!2 Downstream companies : .ot- private and pu.licly3owned : will also add close to @?0 000 ..l=d in .rownfield e9pansion to Indias e9isting refineries2 )oget-er t-is is a -uge medium3term increase in capacity2
Private3sector refiners in particular -ave invested -eavily in India in recent times2 ;rom t-e commissioning of Damnagar II in late32005 to t-e sc-eduled commissioning of (ssars Oadinar II in 2012 private3sector refiners will -ave added around 122 m.=d of new refining capacity (not including Damnagar I!2 )-is is close to t-e si"e of t-e entire current refining capacity of Singapore (t-at is 1220 m.=d! t-e esta.lis-ed refining power-ouse of Sout-3(ast 'sia2 In ,-apter 1 it was argued t-at t-e level of $L,s investment in Indian refining -as not .een significantly affected .y t-e current system of petroleum product pricing t-at .urdens t-ese firms wit- large retail under3recoveries2 In t-e same way it seems t-at private3sector investment -as not .een significantly affected .y t-e distortionary system of product price regulation2 Indeed .y 2012 India will operate private refining capacity of over 2 m.=d2 )-is continued ro.ust investment despite a su.3optimal national pricing framewor6 may .e e9plained .y two 6ey factors2 9
)-e role of $L,s4 's stressed .efore $L,s a.sor. t-e retail losses wit-in t-e current system of pricing2 #-en supplying t-e growing Indian mar6et private3sector refiners are a.le to sell to $L,s at mar6et3.ased refinery3gate prices wit-out carrying any under3 recovery ris62 It is also important to note t-at price restrictions only apply on four products (al.eit t-ose t-at ma6e up a large maAority of domestic petroleum product consumption!2 Private3sector refiners are t-erefore a.le to mar6et industrial fuels lu.es Aet fuel etc2 at mar6et rates wit-out restriction2
1I
(merging national fuel standards in t-e Fnited States are modelled on ,alifornias strict fuel standards w-ic- t-emselves are .ased on (uro3standards2 10I('(200/! Ledium3term $il Lar6et Report Dune p2 5?2
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 9
Page H 12
India as an e9port .ase4 Putting aside t-e regulatory comple9ities of domestic product mar6ets private3sector refiners -ave considera.le incentive to esta.lis- operations in India simply as a .ase for international product e9ports215 Some of t-ese comparative advantages were already discussed in ,-apter @2 India immediately straddles t-e worlds maAor crude producing countries in t-e Liddle (ast to its west and t-e 6ey pole of glo.al petroleum product demand growt- : (ast and Sout-3(ast 'sia : to its east2 Its pro9imity to t-e Liddle (ast also gives Indian refiners access to anot-er rapidly growing mar6et for petroleum products2 Per-aps more significantly Indian production construction and unit la.our costs are far lower t-an in t-e developed world w-ile s6illed la.our and -ig-37uality capital (in terms of .ot- access to financial mar6ets and -ig-3tec- capital mac-inery! are relatively a.undant2
,-art 122 Brownfield refining capacity addition to 2012
)otal Oadinar ((ssar! Langalore (LRP*! Koc-i (BP,*! Refinery Oisa-6 (CP,*! Lanali (,P,*! Caldia (I$,*! Panipat (I$,*! 0 100 000 200 000 L.=d @00 000 100 000
Source4 Linistry of Petroleum and %atural &as (LP%&!2
Lu6es- 'm.ani ,-airman of RI* famously .oasted t-at Damnagar I was .uilt Jwit- dou.le t-e men at -alf t-e cost and in -alf t-e timeK typically e9pected for large3scale refinery proAects2 1/ Damnagar II was completed in @I mont-s from concept to commissioning : a glo.al .enc-mar6 for a refinery of its scale and comple9ity2 I$,*s @00 000 ..l=d greenfield refinery proAect currently under construction for e9ample is employing a temporary construction wor6force of over 100 000 la.ourers : a mo.ilisation t-at would li6ely .e impossi.le outside of a -andful of nations sucas India (and e2g2 ,-ina and Indonesia!2 'fter t-e approval to construct Damnagar II Lr2 Deet Bindra ,-evron )e9acos Cead of &lo.al Refining admitted t-at esta.lis-ing refineries in developed countries was 7uic6ly .ecoming unvia.le w-en matc-ed
15
In fact several private3sector e9port3only refineries -ave .een planned in t-e past alt-oug- none -ave .een successfully put in place as yet2 See t-e discussion of t-e proposed )otal S2'2 refinery proAect .elow2 1/Vuoted in #all Street Dournal J&iant $il Refinery in India S-ows ;orces Roiling IndustryK 2/=05=200I2
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 against -uge 'sian comple9es sucas Damnagar2?0 Instead of loo6ing to e9pand capacity in t-e Fnited States t-erefore ,-evron too6 a small (?N! sta6e in t-e Damnagar comple9 wit- plans to increasingly rely on product imports to t-e Fnited States rat-er t-an domestic refining2 Despite t-e current regulatory conditions t-ere are t-erefore compelling cost commercial and competitive reasons for private3sector firms to loo6 to esta.lis- e9port3oriented refining operations in India2 Page H 1@ ,-art 1@2 &reenfield refinery proAects to 2012
)otal Oadinar II ((ssar! Refinery Bina (BP,*! B-atinda (CP,*! ,uddalore (%agarAuna! Paradip (I$,*! 0 @00 000 I00 000 L.=d /00 000 1 200 000
Source4 Linistry of Petroleum and %atural &as (LP%&!2
International oil companies and t-e glo.al recession

#-ere are t-e JLaAorsKM
' 6ey feature of Indias downstream sector currently is t-e a.sence of refinery operations and investment .y International $il ,ompanies (I$,s!2?1 (ac- of t-e LaAors -as mar6eting and distri.ution operations for industrial fuels and lu.es in India and S-ell -as a permit to esta.lisretail outlets (as t-e only foreign3owned company wit- t-is rig-t!2 ?2 Cowever none of t-e LaAors or any ot-er foreign3owned petroleum corporation -ave refining operations in India2 $nly ,-evron -as (small! e7uity -oldings in e9isting refineries as noted a.ove2 I$,s -ave s-own considera.le interest in Indian refinery proAects in t-e recent past -owever in all cases t-ey -ave pulled t-eir interest at critical stages2 In mid3Septem.er 200/ )otal S2'2 pulled out of a planned Aoint venture @00 000 ..l=d Je9ports3 onlyK refinery proAect in Oisa6- in 'nd-ra Prades- -eaded .y CP,* and including t-e Littal
?0 ?1
See article as a.ove #all Street Dournal 2/=05=200I2 It s-ould .e noted t-at t-e lac6 of I$,s presence in refining sectors is common across t-e 'sia3Pacific region and not Aust India2 'ccording to ;',)S (nergy /1N of refinery investment in developing 'sia to 2012 will .e underta6en .y Jlocal companiesK (e2g2 RI* (ssar etc2! or %ational $il ,ompanies2 )-e implication is t-at I$,s may simply .e more comforta.le concentrating large3scale ris6y investments in mature mar6ets w-ere legal and commercial framewor6s are .etter esta.lis-ed2 ?2)-e LaAors are4 (99on3Lo.il S-ell BP ,-evron3)e9aco ,onoco3P-illips and )otal2
&roup after Littal put on -old its participation in %ovem.er 20052 *and -ad .een purc-ased .y CP,* to -ouse t-e refinery2 )otal pointed to t-e recent collapse in glo.al petroleum product demand as t-e 6ey reason for its decision2 Before t-is .ot- (99on and BP -ad e9pressed interest in Aoint partners-ips wit- CP,* to esta.lis- t-e B-atinda refinery in PunAa. State (w-icis now going a-ead as a Aoint3venture .etween Littal &roup and CP,*!2 In 2000 (99on3Lo.il Page H 11 pulled out of an agreed partners-ip wit- CP,* to Aointly construct t-e 150 000 ..l=d refinery2 *ater in 200? BP signed an L$F wit- CP,* agreeing to ?04?0 e7uity partners-ip in t-e esta.lis-ment of t-e proAect -owever BP pulled out less t-an si9 mont-s later2 S-ell on t-e ot-er -and -as not e9pressed interest at all in any particular refining proAect2 S-ell representatives -ave reportedly stated recently t-at Jw-ile product mar6eting is a current priority t-ere is no reason to say t-at we will not .e loo6ing at a refining assetK2 It is not e9pected -owever t-at S-ell will consider refining proAects in India .efore 201?2
It is 7uite difficult to pinpoint t-e reason for I$,s tentativeness in entering t-e Indian refining mar6et indeed in entering 'sia3Pacific mar6ets in general2 In t-e case of India it may .e partly t-e result of a case of ;irst3Lover 'dvantage at play in t-e private3sector refining sector2 'side from )otals Oisa6- proAect t-e e9planation t-at I$,s -ave eac- given for t-e .rea6down and lac6 of refining proAect plans is t-e e9istence and rapid e9pansion of RI*s Damnagar comple92 In a single am.itious move : t-e .uilding of Damnagar I : RI* effectively saturated t-e e9port3 oriented refining mar6et in India2 RI* t-en .uilt on its e9tensive p-ysical infrastructure and maturing international trade and distri.ution networ6s to furt-er dominate t-e private3sector refining industry in India wit- t-e development of Damnagar II2 RI*s large initial investments -ave to t-is point crowded out refinery investments .y I$,s w-o will naturally weig- up investment options across a num.er of geograp-ic locations2 )-is is not to suggest t-at t-is situation will remain permanent2 #it- t-e slowing of RI*s own capacity additions in t-e medium3term and t-e furt-er growt- of world 'sian and Indian product mar6ets over time t-e commercial and competitive drivers discussed a.ove t-at ma6e India an attractive destination for refinery investment are li6ely to .e re3asserted2 )-e emergence of (ssar (al.eit currently on a smaller scale! as a competing operator wit- RI* on Indias #est ,oast is an indication of t-e .eginning of t-is process2
I$,s unwillingness to invest in refining in India may also .e partly e9plained .y Indias system of product pricing2 It -as .een argued in .ot- t-is c-apter and t-at preceding it t-at neit-er private3sector nor $L, refining investment -as .een significantly affected .y Indias current system of price controls2 )-is is undisputedly t-e case2 Bot- private3sector and pu.lic3sector companies -ave invested -eavily in additional refining capacity recently2 Cowever t-is assessment is .etter confined to local private3sector firms2 #-ile t-e operations of a Jlocal petroleum companyK sucas RI* are concentrated overw-elmingly in its -ome country (in w-ic- it is li6ely to -ave -ig-ly em.edded well3esta.lis-ed commercial associations and supply3 c-ain lin6ages! I$,s -ave operations across t-e glo.e and as mentioned will weig- up investment options across a num.er of geograp-ic locations2 #-en c-oosing a destination for costly and -ig-ly capital intensive refining investments I$,s are naturally li6ely to avoid t-ose locations sucas India w-ere t-ey are currently una.le to profita.ly enter retail mar6ets and roll3out glo.al corporate .rands to consumers2 #-ile local private3sector refiners very profita.ly supply Indias domestic mar6ets via sales to $L,s I$,s will li6ely demand deeper mar6et penetration and clear .rand access from a destination for large3scale ris6y investment despite t-e si"e of Indias domestic mar6et2
Impacts of t-e glo.al recession

's wit- t-e rest of 'sia t-e glo.al economic downturn since 2005 -as -ad relatively little impact on refining capacity proAects in India2 )-e fact t-at investment is .ased on e9pectation of long3term growt- means t-at pre3financed refinery developments are unli6ely to .e disrupted .y s-ort3term macroeconomic fluctuations no matter -ow severe2 'll planned investments are Page H 1? e9pected to go a-ead appro9imately according to original timeframes e9cept for (ssars construction of its 100 000 ..l=d Oadinar II refinery in &uAarat w-ic- -as a revised start3up date of late32012 compared to late320102 (ssar -as .lamed a tig-ter financing environment and uncertainties over t-e pace of glo.al product demand recovery for t-e delay2 )-e current glo.al economic slowdown -as -owever affected a very small num.er of early3stage refinery investment proposals sucas t-e proposed Aoint venture refinery proAect .etween )otal S2'2 CP,* and Littal &roup2 In reality t-e glo.al recession is only one cause of t-e .rea6down of t-ese fledgling proposals w-icis also t-e result of long3term concerns of emerging structural e9cess capacity in 'sia as well as t-e planned removal of several of t-e &oIs ta9 -olidays for refineries commissioned after 20122
Implications of Indias growing e9cess capacity

#it- forecasted total domestic refining capacity of 12/I m.=d .y 2012 India will .ecome t-e worlds fourtlargest refining centre after t-e Fnited States ,-ina and Dapan2 'lt-ouge9pected to grow strongly Indian product demand to 2012 will grow far less rapidly t-an additions to its domestic refinery capacity2 India currently consumes petroleum products at a rate of Aust over @ m.=d growing .ris6ly at slig-tly more t-an 1N per annum to @211 m.=d in 20122 By 2012 t-erefore domestic refining capacity will e9ceed product demand .y over 12? m.=d2 'ssuming refinery capacity utilisation of slig-tly .elow 100N .y 2012 India will .e in a position to e9port appro9imately 121 m.=d of refined product to glo.al mar6ets2?@ )-is would ma6e India 'sias largest refined product e9porter surpassing Singapore : w-icis e9pected to e9port 122 m.=d2 's soug-t .y its 11t- ;ive3+ear Plan t-erefore India seems li6ely to .ecome 'sias preeminent refined product e9porter in t-e s-ort3to3medium3term and one of t-e worlds largest petroleum product e9porters2
#it- t-e esta.lis-ment of t-e world3leading Damnagar comple9 and t-e imminent start3up of close to 122 m.=d of -ig-ly comple9 greenfield refinery capacity India loo6s li6ely in particular to dominate 'sian e9ports of -ig-est 7uality products sucas -ig-3octane gasoline al6ylate ultra3low sulp-ur diesel and petco6e2 )-e emergence of t-is large3scale and comple9 refinery capacity in India will greatly increase t-e resilience of regional supply3c-ains for t-ese -ig-3end industrial and auto fuels2 Putting aside regional industry cycles t-at fluctuate .etween scarce and e9cess capacity t-e esta.lis-ment of India along wit- Singapore as a consistent large3scale e9porter of refined products in 'sia in all cyclical conditions and from period3to3period will su.stantially deepen and strengt-en refined product trade flows in t-e JIndian $cean rimK (stretc-ing from 'frica and t-e Liddle (ast in t-e west to Sout-3(ast 'sia (ast 'sia and 'ustralia in t-e east!2 )-is will .e especially t-e case for diesel Aet fuel gasoline and as mentioned comple9 -ig-3end product trade flows and supply c-ains2 ,urrently 'sia3Pacific trade in refined product is
?@
)-is calculation is supported .y a range of sources including ;',)S (200/! 'sia3Pacific $il Product Balances $il Data.oo6 III 'pril2
relatively small compared to total product consumption2 In 2005 'sia3Pacific countries toget-er imported around ? m.=d of refined product out of total consumption of over 21 m.=d2 )-is is compared wit- (urope for e9ample w-ere close to 10N of total product demand is sourced from outside t-e country in w-ic- it is consumed2 'sia3Pacific countries are t-erefore -ig-ly reliant on domestic refining to meet demand and trade lin6ages in refined product are wea6 Page H 1I and under3esta.lis-ed2 )-is situation contri.utes significantly to limited fle9i.ility in product supply c-ains ma6ing .ot- s-ort3term product supply disruptions and long3term adAustment to increasing import dependence muc- more pro.lematic2 ,-art 112 Indian refining capacity vs domestic demand 200/312
? Refining ,apacity 12? Domestic Demand
1 L.=d
@2?
@ 200/ Source4 LP%& and L)$LR2 2010 2011 2012
)-e addition to 2012 of over 1 m.=d of traded refined product cargoes in 'sia emanating from India (.etween 'pril and Duly 200/ a.out 0?N of product e9ported from Si66a port at Damnagar was destined for t-e Indian $cean rim! will significantly increase t-e dept- of product flows in t-e Indian $cean and strongly contri.ute to growing fle9i.ility in regional supply c-ains2 )-is additional 1 m.=d of traded product is close to 20N of 'sia3Pacific countries total e9pected imports of refined product (i2e2 I m.=d! .y 20122 It is difficult to predict e9actly to w-ere Indias growing petroleum product e9ports will .e destined once demand in %ort- 'tlantic mar6ets recovers2 Cowever even if e9ports are somew-at diverted to meet demand in (urope and t-e Fnited States t-is will displace #estern mar6ets demand for refined product from traditional e9porters in 'sia sucas Singapore Dapan and Sout- Korea freeing3up significant e9port volumes for trade centred wit-in 'sia2
)-e recent deepening of Indian $cean rim refined product mar6ets significantly led .y Indian e9port3oriented product volumes is one of t-e most important developments in glo.al petroleum product mar6ets to occur in recent years and a pattern t-at is li6ely to accelerate over t-e ne9t decade2?1 It implies a fundamentally c-anging configuration of glo.al refining in
?1
See for e9ample $P(, (2005! #orld $il $utloo68 ;',)S (nergy (200/! 'sia Pacific $il Product Balances4 Data.oo6 III8 ;',)S (nergy (200/! 'sia Pacific Refinery ,onfiguration and ,onstruction4 Data.oo6 II8 and (I' (200/! International (nergy $utloo62
w-ic- increasingly refined product is mass3produced in w-at may .e termed JSout- 'siaK : a region .roadly encompassing t-e Liddle (ast India and Sout-3(ast 'sia : and t-en e9ported along increasingly resilient trade routes and ro.ust supply c-ains to .ot- mature economies and smaller emerging mar6ets t-at loo6 to t-ese producer -u.s to supply incremental product demand growt- over time2 )-is is a case of comparative advantage asserting itself in increasingly open international energy mar6ets2 ;or slow3growing mature mar6ets (sucas in Page H 10 (urope t-e Fnited States and 'ustralia! it is increasingly unvia.le to underta6e e9tremely costly lengt-y la.our3intensive and regulation3intensive refinery investments (and even upgrades! to meet incremental demand2 )-is is well3understood in Sout- 'sian countries : t-e -uge refinery comple9es of India Singapore and t-e Liddle (ast are designed largely to fill t-is refinery investment gap in t-e #est (w-ere as mentioned no greenfield refinery -as .een .uilt since t-e mid31/50s!2
,-art 1?2 ;orecast 'sia3Pacific refined product e9ports 2012

12I 121 122 (9ports (m.=d! 1 025 02I 021 022 0
Source4 ;',)S &lo.al (nergy2
Increasingly ro.ust refined product supply c-ains in t-e Indian $cean rim will naturally develop from mar6et interactions t-at matc- growing product volumes from producers sucas India wit- refined product deficits in esta.lis-ed mar6ets (especially as economies recover from recession!2 Policy ma6ers -owever s-ould formulate policy tools t-at encourage domestic downstream industries to em.race and engage wit- t-e c-anging geograp-ic configuration of refinery production in order to ensure national li7uid fuels supply c-ains are .est integrated into evolving glo.al patterns of li7uid fuels trade and production2
Ris6s and c-allenges

(merging regional e9cess capacity
)-ere are several ris6s to t-e continued perpetuation of Indias status as t-e largest e9porter of petroleum products in 'sia t-at need to .e overcome in t-e ne9t decade2 )-e most pressing of
t-ese is t-e almost unprecedented emergence of structural e9cess refining capacity across t-e 'sia3Pacific region2 Strong India refinery capacity addition -as .een mirrored to a large e9tent across t-e region2 'fter adding close to I00 000 ..l=d in 2005 ,-ina is e9pected to add anot-er 500 000 ..l=d of new refining capacity in 200/ : a yearly figure larger t-an Indias capacity additions in t-is year despite t-e start3up of Damnagar II2 't t-e same time .ot- Dapan and Page H 15 Sout- Korea face structurally declining refined product demand com.ined wit- large domestic refinery industries and t-erefore growing domestic e9cess capacity2 In t-e conte9t of very wea6 local regional and glo.al demand smaller refiners sucas )-ailand and )aiwan are also li6ely to face increasing surplus capacity from 200/2 Regional e9cess refining capacity is conse7uently e9pected to increase s-arply from 121 m.=d in 2005 to @2/ m.=d in 20102 Refiners across t-e region will t-erefore .e loo6ing to t-e same e9port mar6ets to a.sor. t-eir surpluses2 ?? 'lternatively refineries will .e forced to significantly cut runs or to consider sectoral consolidation (as is li6ely in Dapan and to a lesser e9tent Sout- Korea!2
Fnfortunately for refiners needing to rapidly increase e9ports glo.al refined product demand is still reeling from t-e worst negative demand s-oc6 to affect international oil mar6ets since t-e early31/50s2 )-e capacity for glo.al mar6ets to a.sor. regional e9cess capacity is t-erefore strictly limited2 ?I )-e 'sian refining industry is t-us .racing itself for a painful period of significant mar6et oversupply and -istorically3low refining margins (and as a result lower crude t-roug-put and sectoral structural adAustment!2 's an indication of t-e li6ely e9tent of refining margin depression w-en regional e9cess refining capacity reac-ed 121 m.=d (significantly less t-an t-at forecast for t-e period 200/312! t-e Singapore gross crac6ing margin remained very low at FSD 020?=..l2?0 'sian refiners in general can t-erefore e9pect to continue t-e current period of low margins wea6 crude runs commercial -ards-ip and industry rationalisation2
Indian refiners are li6ely to fare significantly .etter t-an competitor refineries in ot-er 'sian countries2 ;irstly t-e large scale and world3leading comple9ity of Indias new greenfield refineries mean marginal costs of production are significantly less t-an older less comple9 facilities t-ere.y increasing refining margins2 Secondly Indias new refinery capacity is e7uipped to process -eavier and c-eaper crude grades again putting upward pressure on refining margins .y lowering input costs2 ;inally as mentioned Indian refineries are configured to produce comple9 -ig-3end products w-ic- will retail in international mar6ets for somew-at of a premium2 )-is too will support refining margins2 )-e a.ility of t-e Indian refinery sector to avoid t-e worst conse7uences of regional e9cess capacity and to maintain mar6et s-are as a result of uni7ue clean and -ig-3end product slates will at t-e same time directly worsen t-e difficulties of refiners in Dapan Sout- Korea and Sout-3(ast 'sia during t-e e9pected period of cyclical over3capacity2 's ;',)S (nergy puts it Jwit- t-e emergence of sop-isticated Indian operations Zt-e esta.lis-ed refining centres[ will find t-ey are living in a world very different to t-e one t-ey are accustomed to2 ;rom late3200/ Indias esta.lis-ment as a very low3cost product e9port -u. will .ring intense competitive forces to .ear on less sop-isticated e9port3
??
#-ile t-e Liddle (ast currently faces a deficit of 6ey transport fuels large3scale refinery proAects sc-eduled to come online after 2011 will more t-an a.sor. t-is deficit furt-er increasing competitive pressures in Indian $cean rim product mar6ets2 ?I)-e e9tent of t-e a.sorption of rapidly growing e9cess refinery capacity in 'sia will depend to a large e9tent on product demand in ,-ina2 If demand growt- is wea6 and does not 6eep pace wit- ,-inas domestic refinery capacity addition ,-inese refiners too will loo6 to international mar6ets to a.sor. surpluses adding to oversupplied mar6ets2 $n t-e ot-er -and if ,-inas demand grows faster t-an refinery capacity ,-ina will loo6 to regional mar6ets to meet demand somew-at dampening t-e e9tent of t-e e9pected product glut2 ?0;',)S (nergy (200/! 'sia Pacific $il Product Balances4 Data.oo6 III 'pril pp2 1312
oriented refineries in 'sia particularly in Singapore adding to t-e pro.lems associated wit- t-e financial crisisK2?5 Despite t-e significant factors in t-eir favour -owever Indian private3sector refiners (and to a lesser e9tent $L,s! will not .e a.le to completely avoid t-e com.ined commercial impact of mar6et glut and s-oc6ed glo.al demand2 *i6e t-e rest of 'sias refiners alt-oug- to a lesser e9tent in t-e s-ort3to3medium3term Indias refiners will .e forced to endure an undefined Page H 1/ period of commercial difficulty2
;alling refinery investment in India

(merging evidence of developing regional e9cess capacity in t-e s-ort3to3medium3term -as rapidly -alted t-e surge in refinery capacity investment in India2 'fter 2012 and t-e proAected completion of (ssars large Oadinar II refinery proAect .ot- $L,s and private3sector firms -ave a lac6 of firm plans for significant refining capacity e9pansions2 Recognising t-e potential for a regional refining capacity glut in t-e future t-e &oI -as reduced refinery capacity addition as 6ey commercial priority removing its income ta9 -oliday on refinery proAects commissioned after 20122 ,learly Indian refiners are preparing for a difficult period of wea6 average refining margins and lower crude runs and c-oosing to consolidate operations rat-er t-an to e9pand2 )-e e9pected plateau in Indian refinery investment -as significant implications for Indias status as a maAor glo.al li7uid fuels -u.2 In contrast to slow refinery capacity addition after 2012 domestic demand in India is e9pected to e9perience strong ro.ust growt- wit- t-e last vestiges of t-e glo.al recession li6ely to -ave disappeared2 's ,-art 1I illustrates t-ere will t-erefore certainly .e a reduction in Indias e9cess refinery capacity2 It is notewort-y to compare ,-art 1I depicting Indian product demand versus refinery capacity addition to 2012 wit- ,-art 11 a.ove2 )-e reduction in e9cess capacity will inevita.ly result in lower product e9port volumes emanating from India2 Indeed wit- strong domestic demand and sluggiscapacity addition .y 201? India is no longer forecast to .e t-e largest refined product e9porter in 'sia wit- e9ports falling to Aust over 122 m.=d2?/ Singapore on t-e ot-er -and is e9pected to e9port around 121 m.=d in 201I2
In t-e face of strongly growing domestic demand for India to truly cement its position as a maAor international petroleum product e9porter Indian refiners : .ot- pu.lic and private : will -ave to maintain fairly -ig- degrees of investment to preserve levels of e9port3oriented refining capacity2 )-ere are -owever certain financial .arriers to t-e ac-ievement of t-is sustained level of refinery investment2 Private3sector refiners on t-e one -and are entering a period of uncertainty insta.ility and cyclical e9cess capacity2 )-ey are unli6ely to .e willing or a.le to continue large3scale capacity e9pansion2 )o t-e e9tent t-at $L,s revenues remain dependent on government revenue t-e &oI faces pressure over t-e medium3term to consolidate t-e central .udget and reign in spending2 'lternatively as $L,s .egin to operate in a more open and commercialised fas-ion wit- t-e li.eralisation of product mar6ets over time t-ey too will increasingly face t-e commercial pressures of t-e refining industry Jdown3cycleK2 )-e &oI will
?5
;',)S (nergy (200/! 'sia Pacific Refinery ,onfiguration and ,onstruction4 $il Data.oo6 II 'pril pp2 13?2 ?/'s noted a.ove Indias e9port volumes are li6ely to .e larger t-an t-e aggregate of domestic e9cess capacity as private3sector refiners loo6 to supply glo.al product mar6ets at t-e same rate as domestic ones2 %evert-eless t-e reduction in e9cess capacity will inevita.ly translate into smaller e9port volumes over time as demonstrated .y t-e forecast e9port figures noted2
t-erefore need to .alance product pricing li.eralisation wit- a commitment to up-olding investment plans .y $L,s t-at are aligned wit- t-e downstream sector policy goal of maintaining India as a maAor glo.al refined product e9porter2 ,-art 1I2 Indian refining capacity vs domestic demand 201231? Page H ?0
?2?
12? Refining ,apacity L.=d 1 Domestic Demand

e9cess capacity
@2?
@ 2012 Source4 LP%& and L)$LR2 201@ 2011 201?
(volving from e9porter to genuine -u.

Singapores success wit-in international energy mar6ets -as .een its a.ility to esta.lis- itself as not merely a large refined product e9porter .ut as a truly world3significant li7uid fuels trading -u. and centre of commerce2 Singapore -as .ecome t-e worlds preeminent li7uid fuels trading centre Jeast of Sue"K2 It -as put in place e9tensive and state3of3t-e3art s-ipping -andling and port facilities world3class institutions of trade and commerce and one of t-e worlds largest local fuel storage capacities2 In doing so it -as attracted a large service industry in li7uid fuels (and s-ipping! trading financing consulting management and regulation t-at services t-is dynamic sector2 ' significant proportion of t-e economic Jvalue3addedK of t-e li7uid fuels sector comes from t-e associated service industries rat-er t-an t-e actual p-ysical trade of li7uid fuels2 India in t-e s-ort3term at least will .ecome 'sias largest e9porter of refined product and witSingapore one of t-e two 6ey centres for traded refined product in 'sia2 Cowever it still -as significant progress to ma6e in esta.lis-ing itself as a genuine well3functioning li7uid fuels trading -u. wit- associated and lucrative service industries2 's India -as to some e9tent completed t-e difficult tas6 of esta.lis-ing t-e necessary p-ysical refining capacity for t-e moment t-e transformation to trading -u. is primarily an e9ercise in concerted industry policy and institution .uilding2 In particular t-e &oI needs to esta.lis- t-e institutions of finance commerce and trade wit-in t-e sector2 )-e city of Lum.ai is Indias rapidly growing financial centre and t-e o.vious geograp-ic locus of Indias e9port3oriented refined product sector (witRI* and (ssars -uge facilities located to t-e nort- at Damnagar Langalore refinery to t-e sout-
and close to 100 000 ..l=d of refinery capacity wit-in t-e city itself!2 )-ere is considera.le potential for Lum.ai to develop into a 6ey glo.al centre of li7uid fuels trade leveraging on rapidly increasing Indian product trade and transforming India from a very large refined product producer to genuine trading -u.2 ;or t-is to occur t-e &oI must a.ove all esta.lis- a state3of3t-e3art li7uid fuels trading e9c-ange in Lum.ai t-at facilitates rapid ine9pensive and sop-isticated trade in p-ysical fuels and fuel contracts2 )-is is t-e 6ey institutional .asis for t-e Page H ?1 development of multilateral trade and e9c-ange in refined product rat-er t-an simply one3way product e9ports and a prere7uisite for t-e development of a dynamic secondary sector servicing Indias e9panding e9port3oriented refining sector2
,onclusion and 6ey findings

In 6eeping wit- t-e am.itious goals of t-e 11t- ;ive3+ear Plan India will emerge .y 2012 as 'sias largest refined product e9porter and a maAor glo.al producer of petroleum products2 Indias emerging refined product e9port industry : led .y RI*s Damnagar facility .ut also increasingly supported .y new $L, refineries : is c-aracterised .y e9tremely large3scale low3 cost and modern plants capa.le of processing -eavy crudes and producing comple9 clean products2 )-e addition of around 1 m.=d of traded refined product especially -ig- 7uality product in t-e Indian $cean rim will su.stantially strengt-en li7uid fuel supply c-ains in t-is region and deepen currently3underdeveloped 'sian trade in refined product2 #-ile Indias refining successes are intimately related to t-e natural comparative advantages of t-e country itself it -as also .een fostered .y prudent policies and intervention .y t-e &oI2 ;rom an outcomes perspective t-e policy mi9 c-osen .y t-e &oI for t-e refining sector -as .een -ig-ly successful (al.eit w-ile coming at a tremendous fiscal cost!2 )-e government -as single3 mindedly pursued large3scale investment in refining capacity t-roug- $L,s .y e9tending considera.le financial support to t-ese firms8 .y up-olding confidence in $L,s wit-in capital mar6ets8 and .y providing $L,s t-e freedom to ma6e investment decisions .ased on a range of non3commercial factors as well as strictly commercial ones2 Dust as importantly t-e &oI -as created a domestic downstream sector in w-ic- well3supported $L,s a.sor. t-e significant retail losses in-erent in t-e current system of product mar6et regulation : t-ere.y creating a mar6et3space in w-ic- private3sector refiners can profita.ly conduct .usiness .ased not only on e9port sales .ut on t-e penetration of Indias fast growing domestic mar6et2 )-e appeal of t-is .usiness model -as driven t-e recent .oom in local private3 sector investment in Indian refining t-at -as culminated for e9ample in t-e emergence of Damnagar in &uAarat as t-e worlds largest refining centre : wit- close to 2 m.=d of privately3 owned refining capacity e9pected to .e in place .y 20122 &overnment policy -as t-erefore succeeded in fostering a dynamic com.ination of private and pu.lic investment in refining capacity w-ic- -as transformed t-e face of Indias downstream petroleum sector in t-e years of t-e 11t- ;ive3+ear Plan2
Despite its significant successes in t-e long3term India faces several c-allenges to its growing status as glo.al refining power-ouse2 ,urrent e9tensive investment will certainly ensure t-at India remains a 6ey e9porter of refined product especially in t-e 'sia3Pacific region2 Cowever falling investment in refinery capacity after 2012 owing largely to growing regional e9cess capacity and a tig-ter fiscal environment puts at ris6 Indias emergence as truly one of t-e worlds largest refinery centres in t-e long3term especially in t-e conte9t of growing domestic product demand2 It is difficult to predict t-e e9act traAectory of Indian refinery investment after 201? w-en t-e current wave of investments will
-ave ended2 ,ertainly investment will .e muc- lower and more incremental in nature2 )o a large e9tent investment dynamics post32012 will depend on t-e content of t-e 12t- ;ive3+ear Plan (.eginning in 2012! Aust as t-e 11t- ;ive3+ear Plan -as intimately affected current investment trends2 )-e &oIs move to a.olis- t-e ta9 -olidays on refinery investment and construction occurring after 2012 -owever suggests t-at it is content wit- Indias proAected refinery J.aseK to 2012 and t-at it Page H ?2 will ta6e a less e9pansionary attitude to refinery capacity in t-e future2 #-ile from an outcomes perspective t-e &oIs refinery sector policies -ave .een -ig-ly successful from a cost perspective t-ey -ave .een close to disastrous2 's -as .een descri.ed in order for $L,s to .e in a position to ma6e large3scale refinery investments (and secondly in order for $L,s to .e a.le to continue to incur under3recoveries and t-ere.y to create space for private3sector refiners to prosper! t-e &oI -as .een forced to ma6e payments in various forms to $L,s amounting to close to FSD I0 .illion since 200130?2 )-is figure for e9ample is a.out fifteen times greater t-an was I$,*s refinery investment for t-is same period2 )-e com.ination of managed petroleum product prices and large3scale refinery investment -as t-us .ecome e9tremely e9pensive for t-e &oI contri.uting significantly to an alarming and rapid fiscal overflow since 2005 and temporary concerns of a Jtwin deficitsK crisis2
)-e funding pattern t-at -as largely underpinned Indias refinery .oom is t-erefore clearly and entirely unsustaina.le2 'lt-oug- a great deal of investment -as .een completed India will need to incrementally add refinery capacity after 2012 to maintain its e9port potential2 &iven Indias fiscal circumstances and under rapidly tig-tening .udgetary conditions t-is investment s-ould .e increasingly soug-t commercially from t-e private3sector including from I$,s2 In order to promote increasing private3sector involvement in Indian refining including foreign private3sector involvement t-e &oI must .egin t-e process of product mar6et li.eralisation w-ic- will -elp to foster timely effective investment responses to clear mar6et signals and wor6 to encourage -ig-37uality investment from private3sector refiners2 In turn li.eralisation will reduce t-e dependence of $L,s on t-e &oI for wor6ing capital allowing t-ese companies too to invest in an efficient and timely fas-ion2
Reform to pricing policy in product mar6ets will t-us reduce t-e fiscal .urden of t-e current system of unofficial su.sidies on t-e &oI and promote least3cost refining investment responses2 Sucreform also -as secondary .enefits2 ,lear price signals encourage fuel conservation and su.stitution2 )-is will simultaneously reduce Indias crude import costs and as su.stitution to cleaner fuels occurs green-ouse gas emissions will .e reduced as well w-ile .oosting energy security2 ;or eacof t-ese reasons t-e &oI s-ould move in t-e direction of mar6et3.ased reform in petrol diesel *P& and 6erosene mar6ets2 It s-ould do t-is -owever w-ile employing effective policy tools sucas price ceilings and -ig-ly targeted su.sidies t-at provide energy mar6et access for poor Indians especially in *P& and 6erosene mar6ets2 ,-apter I e9plores t-ese issues of mar6et reform in greater detail2
,-apter I2 ' return to t-e issue of product pricing4 pat-s toward mar6et reform
Page H ?@
Introduction
)-is study -as s-own t-at private3 and pu.lic3sector investment in Indias downstream sector especially in refinery capacity -as .een sufficient to esta.lis- a dynamic domestic industry capa.le of meeting strongly growing Indian li7uid fuels demand and increasingly esta.lis-ing India as a maAor glo.al refined product e9porter2 #-ile private3sector investment -as .een ro.ust and decisive a great deal of t-e .urden of t-is tas6 -as naturally fallen to Indias $L,s t-e largest and most well3esta.lis-ed companies in t-e downstream sector2 $L,s remain financially crippled .y t-e current system of product price regulation2 Fnder current international crude mar6et conditions $L,s need to .e consistently .ailed3out .y t-e &oI for selling product in domestic mar6ets at managed prices2 Similarly effectively3insolvent $L,s -ave -ad to rely directly or indirectly on t-e &oIs oil .ond issuance for wor6ing capital to fund Indias am.itious pu.lic3sector downstream investment programme2
Between ;+ 200130? and ;+ 200530/ t-e &oI pumped over FSD I0 .illion into $L,s to a.sor. product under3recoveries and to ensure $L,s were capa.le of continued rapid investment in capacity2 ,lose to -alf of t-is total occurred in ;+ 200530/2 #it- international crude prices mostly a.ove FSD 00=..l since mid3200/ t-e &oI is li6ely to .e forced to ma6e payments of around FSD 1? .illion in ;+ 200/310 to $L,s to a.sor. under3recoveries2 't t-e same time India currently confronts a fiscal crisis of sorts : t-e acute com.ination of prevailing macroeconomic conditions (w-ic- -ave prompted falling ta9 revenues and rapidly increasing stimulus3related e9penditure! and medium3term .udgetary e9cess2 In ;+ 200530/ Indias government deficit (across all levels of government and including off3.udget components! more3t-an3dou.led in nominal terms to 1121N of &DP2 )otal state and &oI de.t is estimated at 52N of &DP and interest payments on government de.t consume around 21N of t-e &oIs revenues2I0
Fnder t-ese conditions massive e9penditure .y t-e &oI to fund t-e system of JunofficialK product su.sidies is entirely unsustaina.le2 )-e 6ey issue in t-e domestic downstream sector stemming from Indias distortionary refined product pricing regime is t-erefore not one of investment incentives or corporate dynamism : w-ic- are all ro.ust and -ealt-y : .ut one of fiscal cost2 Indeed wit- international crude prices forecast to rise as t-e glo.al economy recovers t-e fiscal cost of t-e current system of petroleum pricing can only .e e9pected to increase significantly over time2 &iven t-ese -uge costs and in t-e conte9t of innumera.le competing priorities and t-e need for strict .udgetary austerity t-e &oI must move decisively in t-e direction of more cost3reflective pricing of petroleum products as was t-e intention of t-e a.olition of t-e 'PL in 20022 )-is c-apter provides a .rief discussion of some different policy
I0
Standard P Poors (200/! JIndia Sovereign ,redit Rating4 Press ReleaseK ;e.ruary p2 22
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 options and potential pat-s towards reform availa.le to t-e &oI2 I1 It does not -owever prescri.e a clear solution to t-e issue of pricing reform2 %aturally pricing reform must not forsa6e t-e issue of e7uity and energy poverty in energy mar6ets for a single3minded fi9ation wit- cost3minimisation2 Indias unofficial petroleum su.sidies are specifically intended to ensure Jt-e common manK is a.le to access and afford Page H ?1 .asic energy needs2 )-is principle s-ould .e up-eld into t-e future2 )-e process of product mar6et reform t-erefore needs to .e -ig-ly nuanced : reducing t-e cost of t-e current system of price regulation and en-ancing price signals w-ile ensuring vulnera.le Indian citi"ens are not e9cluded from energy mar6ets2I2
La6ing mar6ets wor64 t-e secondary .enefits of reform

)-us far t-is c-apter -as discussed t-e need for product mar6et reform largely in terms of t-e fiscal cost of t-e current system of unofficial su.sidies2 )-ere are also ot-er .enefits to increasing mar6et transparency and cost reflectivity w-ic- s-ould .e noted2 )-e first -as to do wit- investment responses wit-in Indias downstream sector2 Fnder current arrangements Indias pu.lic3sector downstream industry relies on a JmanagedK investment model2 $L,s .ase investment decisions on a com.ination of pu.lic policy and e9pected demand and investment capital is sourced from (or at very least indirectly and informally underwritten .y! t-e &oI2 )-is model of sectoral growt- -as .een -ig-ly effective .ut also -ig-ly costly wit- t-e &oI .earing t-e .urden of 6eeping $L,s in a condition to invest strongly2 's in t-e conclusion of t-e preceding c-apter wit- t-e e9pected tig-tening of .ot- .udgetary conditions and international crude mar6ets over time t-e &oI will need to gradually move away from t-is e9pensive model of $L, investment2
Increasingly mar6et3.ased pricing of refined product assists in t-is regard in two 6ey ways2 ;irstly it allows $L,s to operate on a corporatised .asis4 wit-out t-eir vital revenue streams .loc6ed $L,s can profita.ly conduct operations t-at generate investment capital2 Secondly wit- revenue streams restored and investment capital generated mar6et3.ased pricing promotes (alt-oug- of course does not always ensure! ade7uate timely and well3placed investment responses .y providing clear price signals and transparent mar6et drivers for investors2I@ #it- more li.eralised product mar6ets t-erefore $L,s will .e increasingly freed from reliance on t-e current government3funded mode of investment t-at ultimately .urdens future generations2 )-is does not mean t-at t-e &oI $L,s maAority s-are-older need .e completely e9cluded from a role in investment decisions .ut implies instead t-at t-e resources and impetus for investments are derived from outside t-e organs and .udgets of t-e &oI2
)-e second .enefit of mar6et3.ased reform not yet mentioned -as to do wit- allocating energy consumption2 Indias su.sidisation of petroleum products results in over3consumption of t-ese products2 $f course w-en not facing t-e full cost of a product consumers will use it in greater 7uantity t-an w-en t-ey do face full costs2 In t-e case of Indias consumption of petroleum products t-is -as far3reac-ing economic and environmental implications2 $verconsumption of petroleum products inevita.ly e7uates to Indian overconsumption of crude oil 0?N of w-ic-
I1
,urrent economic conditions ma6e t-e perfect conte9t for pricing reform as pent3up inflationary pressures in India and elsew-ere waned significantly in 200/2 's a result t-e &oI can .egin p-ased price rationalisation wit-out concern t-at somew-at -ig-er fuel costs mig-t set off an inflationary spiral2 I2F%(,( (2002! Draft &uidelines for Reforming (nergy Su.sidies p2 @2 I@Lorgan )2 (2000! (nergy Su.sidies4 Cow t-ey 'ffect Investment and &reen-ouse &as (missions p2 1?2
India is re7uired to import2 #it- current crude prices remaining relatively -ig- and .roadly e9pected to rise t-e income effect of Indias -uge crude import .ill is significant2 ,-eap su.sidised petroleum products in India institutionalise -eavy fuel use and t-oroug-ly undermine energy efficiency and conservation2 )-is at once greatly increases Indias crude costs augments its dependence on foreign sources of oil and increases green-ouse gas emissions2 *astly su.sidised fuel prices entrenc- t-e use of fossil fuels and undermine Page H ?? su.stitution into cleaner fuels and energy3producing tec-nologies2 In esta.lis-ing unfettered price signals for increasingly e9pensive petroleum fuels t-e esta.lis-ment of cost3reflective pricing t-erefore implies significant .enefits for India and its economy2 Better functioning price signals wor6 to simultaneously increase energy efficiency reduce green-ouse gas emissions and decrease total crude costs2I1
)-e rationale for t-e &oI to .egin mar6et3.ased pricing reform is t-erefore t-reefold2 ;irstly and most pressingly t-e e9isting system of unofficial su.sidies on petroleum products is unsustaina.ly costly especially given Indias precarious .udgetary position2 Secondly mar6et3 .ased pricing will en-ance t-e functioning and cas-flows of $L,s encouraging timely well3 placed and independently3funded pu.lic3sector refinery investment and reducing t-e reliance on ta9payer funding for t-is purpose2 *astly mar6et prices encourage conservation and su.stitution of petroleum products reducing .ot- crude import costs and green-ouse gas emissions2 )-is is a compre-ensive case2 )-e difficult tas6 to w-ic- t-ere are significant .arriers is t-erefore to design a programme of reform t-at esta.lis-es cost3reflective pricing at t-e centre of product mar6ets .ut t-at at t-e same time ensures petroleum products remain afforda.le to vulnera.le consumers2 )-is is important of course not only from t-e perspective of e7uity .ut from one of political realism as well2 I? )-e rest of t-is c-apter is devoted to a discussion of some of t-e various ways to distil suc- a programme of reform2
)-e possi.le roads to reform (or t-e road less travelled!

Price reform wit- targeted su.sidies
'part from complete price li.eralisation t-e most efficient way for product mar6ets to .e reformed w-ile maintaining a commitment to .road3.ased energy mar6et access is t-roug-ig-ly targeted su.sidies to a small proportion of specifically3defined end users2 )-ese specific end users are issued wit- proof of entitlement to reduced3cost fuels2 )-is same principle may .e applied for firms using fuel inputs in industries of -ig- strategic or social importance for e9ample farmers of staple crops2 )-e use of suc- a tool is powerful2 's long as a sufficiently small proportion of consumers -ave access to su.sidised fuel price mec-anisms in product mar6ets will not .e distorted2II In suc- a situation sensitive consumers are protected w-ile t-e .enefits of mar6et prices (cost minimisation8 least3cost efficient investment responses8 and fuel switc-ing and conservation! are up-eld2
Fnfortunately Indias significant demograp-ic and socio3economic comple9ities render suc- an approac- pro.lematic2 'lt-oug- e9act figures vary India -as -undreds of millions of people living .elow t-e poverty line (BP*!2 Providing targeted su.sidies to -undreds of millions of geograp-ically dispersed individuals is clearly very difficult2 If t-e tas6 is not itself impossi.le
I1 I?
Oon Lolt6e '2 et al2 (2001! (nergy Su.sidies pp2 1?31/2 I.id2 p2 122 IIBas-ma6ov I2 (200@! J(nergy Su.sidies and \Rig-t PricesK in (nergy (fficiency Ool2 @?2
t-e regulatory costs of suc- a sc-eme are pro-i.itive2 ;urt-er given t-e endemic corruption India faces in low3level administration it is -ig-ly unli6ely t-at a precisely targeted system of su.sidies would .e effective in strictly confining t-e distri.ution of su.sidised product to t-e targeted population group2 's t-e Pari6- Report states suc- a system would Jinvolve a comple9 monitoring and inspection structure more li6ely to promote Inspector RaA t-an to effectively I0Page H ?I reduce t-e su.sidyK2 ,urrently for e9ample t-e &oI operates a nominal system of 7uotas for t-e sale of su.sidised 6erosene w-ic- are intended for sale to t-e poorest sections of Indias population2 In practice it is too difficult for $L,s to properly monitor to w-om t-ese products are sold2 ' recent study s-owed t-at in ten of Indias 25 states more t-an ?0N of su.sidised product was sold to .usinesses and industry rat-er t-an BP* card-olders2 #-en sales to non3 BP* individuals were included t-e proportion diverted was as -ig- as 5?N in some states and not less t-an ?0N in ot-ers2
&iven Indias current social comple9ity targeted su.sidies cannot t-erefore provide t-e sole 6ey to product mar6et reform2 )-ey are -owever an e9tremely important component of a larger reform programme especially wit- regard to energy poverty3alleviating coo6ing fuels (as will .e discussed .elow!2 )-e &oI recently introduced a pilot sc-eme in Cydera.ad Bangalore and Pune w-ic- aims to .etter target t-e distri.ution of su.sidised *P& and 6erosene to BP* Indians t-roug- t-e use of new3generation electronic Smart ,ards2 )o t-e e9tent t-at t-is pilot is successful t-is study supports t-e implementation of suc- a sc-eme2 )-e .arriers to effective country3wide implementation and proper governance of a very large targeted product su.sidies system in India at t-e moment -owever are 7uite su.stantial2
)a9ation reform
Since Indias &eneral (lection in Lay 200/ several proposals for t-e reform of petroleum product pricing -ave .een voiced2 Prominent among t-ese -as .een reform to t-e system of ta9es levied on petroleum products2 )-e &oI -as .een cutting e9cise ta9es on petroleum products to ease under3recoveries for some time2 )-e fres- proposals for ta9 reform call for furt-er cuts to e9cise levels in com.ination wit- t-e implementation of a lower state3levied standardised sales ta9 rate2I5 %egotiating a uniform sales ta9 amongst 25 Indian states (plus territories! is li6ely to .e a long and painsta6ing process alt-oug- one t-at s-ould .e underta6en2 Lore importantly marginal reform to t-e system of petroleum product ta9ation is merely a J.and3aidK solution w-ic- fails to solve t-e underlying issue of a.sent cost3reflectivity in product mar6ets2 ,utting petroleum ta9es furt-er s-ould not even .e considered a prudent s-ort3term interim measure to stem under3recoveries2 By cutting ta9es t-e &oI undermines a crucial source of revenue one t-at is e9tremely important given current .udgetary conditions and w-icmay .e spent in support of .asic developmental programmes2 *astly reducing ta9es now will ma6e it very difficult for future governments to raise ta9ation rates on petroleum products again and -ence deprives policy ma6ers of a 6ey demand3side management and environmental policy tool2
I0
&overnment of India (2010! Report of t-e (9pert &roup on a Oia.le and Sustaina.le System of Pricing Petroleum Products ;e.ruary p2 2@2 I5)-ese proposals are descri.ed in Indian $il P &as (200/! J;urt-er )a9 ,uts on Petrol ProductsMK Ool2 1@ %o2 122
Price ceilings
In Lay 200/ LP%& released a proposal for reform of diesel and petrol mar6ets .ased on t-e esta.lis-ment of a price ceiling under w-ic- product prices are allowed to fluctuate2 Fnder t-is proposal $L,s are free to set fuel prices every t-ree mont-s .ased on a 7uarterly average of glo.al crude prices2 )-is will occur until crude prices reac- FSD 0?=..l at w-icpoint t-e &oI Page H ?0 will intervene wit- price controls to protect consumers2 )-is proposal is tacitly .ased on t-e notion t-at it is e9treme product prices t-at cause t-e lions s-are of damage to consumers .udgets and to economies2 ;or all .ut t-e very poorest mar6et outcomes will not cause significant increases in individual -ards-ip in most instances especially in petrol and diesel mar6ets2I/ )-e role of su.sidies s-ould t-erefore .e to insulate consumers from t-e e9treme end of t-e petroleum product pricing range w-ile allowing mar6ets to function at ot-er times2 00 )-e section .elow loo6s at t-e issues wit- LP%&s proposal and ways t-at it mig-t .e modified2 %ote t-is is meant as a policy discussion rat-er t-an as offering a concrete solution to t-e issue of pricing reform2
(sta.lis-ing wor6a.le price ceilings in Indian product mar6ets

' 6ey s-ort3coming wit- LP%&s Lay 200/ proposal is t-at it fails to properly consider t-e realities of international crude mar6ets2 In Lay concerns remained a.out t-e state of t-e glo.al economy and crude .enc-mar6 prices -overed around FSD ??=..l2 Indeed witeconomic recovery crude prices were clearly destined to rise from t-is level2 #it- t-e o.served J.ottomingK of t-e glo.al economy LP%&s price ceiling of FSD 0?=..l -as 7uic6ly .ecome too conservative2 'lt-oug- .enc-mar6 prices only fairly recently reac-ed FSD 0?=..l since t-ey touc-ed a cyclical .ottom of FSD @2=..l in early 200/ furt-er economic recovery is li6ely to sustain still -ig-er prices in t-e near term2 ;or t-e purposes of reform it is little use esta.lis-ing a price ceiling w-icis consistently in effect2 LP%& s-ould e9amine t-e possi.ility of price ceilings for product mar6ets especially petrol and diesel mar6ets w-ic- are somew-at -ig-er t-an FSD 0?=..l201 )-ese ceilings need not .e significantly -ig-er2 's t-e (I' argues in its %ovem.er 200/ S-ort3term (nergy $utloo6 t-e world can still e9pect a significant period of relatively su.dued crude prices as -opes of an economic recovery are .alanced witpersistently wea6 demand and -istorically -ig- inventories202 Price ceilings s-ould -owever .e -ig- enoug- to create to .egin wit- at least a J.ufferK .etween current prices and t-e ceiling in w-ic- mar6et prices can fluctuate2
)-e &oI s-ould consider two different price ceilings t-at reflect two very different petroleum product mar6ets : one for petrol and diesel and one for *P& and 6erosene2 Petrol and diesel
I/
)-is is not to say t-at Indias population will .e -appy wit- a removal of price controls2 It is instead argued t-at in most periods and for most individuals mar6et prices will not cause maAor -ards-ip especially in petrol and diesel mar6ets2 00#-ile LP%&s proposal sees Je9tremeK prices as t-ose a.ove FSD 0?=..l e9treme prices -ere (ta6ing into account credi.le medium3term crude price forecasts! are seen as t-ose a.ove appro9imately FSD 1103120=..l similar to t-ose e9perienced in t-e crude price3spi6e of mid3 20052 01Suggesting e9act price ceilings for different Indian product mar6ets is .eyond t-e scope of t-is paper2 02(nergy Information 'dministration (200/! S-ort3)erm (nergy $utloo6 %ovem.er2 Indeed $P(, -as made clear t-at t-ey see FSD 0?=..l as a JfairK target crude price for .ot- producers and consumers2
are primarily transport fuels used a.ove all .y t-ose wit- access to private ve-icle transport2 Diesel does -ave social uses in t-e transport of staple products in pu.lic transport and for use in agricultural production20@ Cowever t-e maAority of petrol and diesel in India is consumed .y middle class Indians wit- access to private ve-icles2 )-e &oI s-ould t-erefore consider relatively -ig- price ceilings on petrol and diesel allowing mar6et prices to ta6e affect in most instances Page H ?5 w-ile insulating consumers at times of very -ig- prices (realistically defined!2 )-e social uses of diesel especially for pu.lic transport and use in agriculture may t-en .e protected .y direct su.sidisation of t-ese activities t-emselves as suggested .y t-e #orld Ban62 01 Depending on e9actly w-ere t-e price ceiling for petrol and diesel is esta.lis-ed a relatively -ig- ceiling (e2g2 of FSD /?310?=..l! can .e e9pected to increase petrol and diesel prices .y around I%R /310=litre (from current levels around I%R @@=litre for diesel and I%R 1?=litre for petrol! at t-e -ig-er reac-es of t-e price scale according to Platts20? )-is Aump in prices will over time increase fuel conservation and switc-ing in India and wor6 to promote increased retail competition in t-e downstream sector2 't t-e same time it s-ould mostly impact middle3class and wealt-y Indian citi"ens greatly diminis-ing t-e overall welfare effect2 *P& and 6erosene on t-e ot-er -and are increasingly used as coo6ing fuels .y Indias poor population20I )-e c-eap su.stitute for t-ese fuels is t-e -a"ardous practice of .urning .iomass in t-e -ome2 )-e importance of accessi.le *P& and 6erosene to t-e -ealt- and living standards of Indias poor means t-at t-e price of *P& and 6erosene is a -ig-ly sensitive developmental issue2 $f course t-ese fuels are widely used in industry (and 6erosene is an almost perfect su.stitute for Aet fuel!2 Cowever prices cannot .e li.eralised in t-e same simple fas-ion as t-ose of diesel and petrol2 %eit-er t-oug- s-ould -ealt-y Indian industries .enefit from costly su.sidies aimed at poorer individuals2 In order to .alance t-ese competing social and economic o.Aectives t-e &oI s-ould to .egin wit- assess t-e success of its am.itious Smart ,ard sc-eme for su.sidised 6erosene and *P& distri.ution2 ,learly India needs a means to effectively supply poor -ouse-olds wit- afforda.le coo6ing fuels .efore *P& and 6erosene mar6ets can .egin to .e properly deregulated2 If t-e Smart ,ard sc-eme succeeds in more effectively targeting poor Indian -ouse-olds LP%& s-ould consider moving towards li.eralised mar6ets wit- price ceilings alt-oug- t-ese ceilings mig-t .e 7uite low initially2 If t-is pilot proAect is not successful LP%& must loo6 to concentrate its energies in t-oroug- reform of t-e distri.ution of su.sidised *P& and 6erosene2 $nly t-en are t-e conditions created for deeper structural pricing reform in t-ese 6ey mar6ets2
' transition to li.eralised mar6ets

,omple9ities in t-e consumption patterns and uses of different petroleum products t-erefore mean pricing reform across product mar6ets re7uires a com.ination of .ot- regulated mar6et3 .ased reform and targeted su.sidies2 In addition to t-is as argued in ,-apter @ (and included in
0@
In pricing matters diesel and petrol need to .e treated toget-er as t-ey are almost perfect su.stitutes2 Lore la9 treatment of one will merely cause a s-ift in demand away from t-e ot-er2 01,ropper L2 (2001! JPu.lic )ransport and 'fforda.ility in Lum.ai IndiaK #orld Ban6 #or6ing Papers2 0?If retail prices were to .e li.eralised wit- glo.al crude prices .etween FSD 00350=..l it is estimated t-at retail diesel and petrol prices would increase .y around I%R 1=litre2 See Platts (200/! JIndia ta6es a fres- loo6 at fuel pricing reforms 3 t-roug- anti7ue glassesK 1 Decem.er2 0IKerosene is used muc- more widely t-an more e9pensive *P& for coo6ing .y BP* Indians2 Cowever *P& is a cleaner3.urning -ealt-ier fuel a fact t-at -as motivated t-e &oI to attempt to foster t-e increasing use of *P& .y BP* Indians2
Indias Downstream Petroleum Sector : < $(,D=I(' 2010 t-e 11t- ;ive3+ear plan! India s-ould wor6 to esta.lis- national petroleum product mar6ets wit- uniform state3levied ta9es on products2 'lt-oug- t-is will .e a painsta6ing process in t-e conte9t of -ig-er prices due to mar6et li.eralisation national mar6ets will reduce t-e natural upward pressure on prices resulting from Jta9 creepK : i2e2 t-at resulting from t-e temptation of regional governments to periodically levy a variety of additional duties on t-e sale of petroleum products2 $f course transparent national petroleum mar6ets -ave ot-er significant Page H ?/ additional .enefits in providing investor certainty and en-ancing t-e downstream .usiness environment2 In petrol and diesel mar6ets price ceilings t-at are esta.lis-ed in t-e process of mar6et reform s-ould .e upwardly fle9i.le wit- t-e intention of p-asing t-ese out over a certain sufficiently lengt-y period t-at allows adAustment to li.eralised mar6ets2 )-ese timeframes of course s-ould .e clearly indicated .y t-e &oI during t-e process of reform2 'dAustments in price ceilings s-ould ta6e place on t-e .asis of clear criteria relating to consumer price inde9 c-anges .road c-anges in incomes and consumption patterns t-e effectiveness of parallel su.sidies (for e9ample t-ose for pu.lic transport! c-anging fuel intensity and t-e e9tent of fuel switc-ing200 ;urt-er .ot- revisions to price ceilings and t-e eventual p-asing out of price controls s-ould .e monitored and underta6en .y an independent .ody : e2g2 t-e P%&RB : in order to avoid t-e politicisation of decisions2 's -as .een mentioned compre-ensive li.eralisation of *P& and 6erosene mar6ets first re7uires t-e esta.lis-ment of an effective system of distri.ution for su.sidised coo6ing fuels to BP* Indian -ouse-olds (effectively a well3 functioning parallel mar6et!2 )o t-e e9tent t-at t-is system is successfully esta.lis-ed and perfected over time *P& and 6erosene mar6ets may ta6e a similar structure to t-at proposed for petrol and diesel mar6ets including t-e gradual upward revision and p-asing out of price ceilings as consumers and industry adapt to more li.eralised mar6ets2
(pilogue
Petrol and diesel mar6ets are t-erefore ripe for t-e &oI to .egin pricing reform2 )-is need not occur rapidly2 Before semi3permanent price3ceilings (of t-e 6ind e9plored a.ove! are esta.lis-ed in petrol and diesel mar6ets t-e &oI oug-t to slowly increase current ma9imum prices for products so as to ease t-e transition to -ig-er and somew-at more permanent price ceilings2 Increasingly li.eralised petroleum and diesel mar6ets would represent a significant step in reducing t-e massive cost of product su.sidies for t-e &oI2 In ;+ 200530/ under3recoveries on t-e sale of petrol and diesel in India e9ceeded FSD 1? .illion close to I0N of t-e total under3 recovery .urden2 $f course during a transition to mar6et prices under3recoveries on t-e sale of diesel and petrol would not disappear2 In fact secondary su.sidies protecting t-e social uses of diesel (e2g2 in pu.lic transport! would li6ely need to .e put in place representing an additional fiscal cost2 %evert-eless t-e &oI s-ould anticipate -uge savings in t-e form of foregone de.t issuance as a result of p-ased pricing reform in petrol and diesel mar6ets especially if crude prices rise in t-e s-ort3to3medium3term2
)-e li6ely investment effect occurring wit-in Indias downstream petroleum sector in t-e long3 term as a result of pricing reform -as .een e9plored a.ove2 )-e &oI s-ould not -owever e9pect to see a rapid e9pansion of private3sector refining investment in response to deregulated
00
LP%& s-ould loo6 to tas6 PP', wit- collection of data pertaining to t-ese criteria (or w-ic-ever criteria t-ey devise! so t-at transparent and fully3informed decisions may .e made .y .odies assessing t-e level of price ceilings2
prices in t-e s-ort3term2 'lt-oug- I$,s and ot-er private3sector refiner3retailers are li6ely to .e strongly drawn .y t-e opening of Indian product mar6ets (and especially product retail mar6ets! refinery capacity investment in t-e 'sia3Pacific region in general will .e muted .y close3to3unprecedented regional e9cess refining capacity in t-e period to 201231@2 )-is study -as argued t-at refinery investment in India s-ould .e increasingly soug-t from t-e Page H I0 private3sector in t-e long3term2 )-e natural unpredicta.ility and JlumpinessK of private3sector refining investment -owever com.ined wit- t-e traditional .oom3.ust pattern of glo.al and regional refining investment provides a Austification for retaining a degree of government involvement in Indian downstream sector investment w-ere -ig-3speed demand growt- and dynamic commercial opportunities re7uire decisive and early investment responses to avoid supply s-ortfalls2 (specially in t-e period to 201231@ t-e &oI s-ould loo6 to maintain its tacit control over $L,s strategic e9penditures even as $L,s reliance on government revenue for wor6ing capital gradually diminis-es wit- more li.eral pricing2 In t-is way t-e &oI can ensure t-at t-e incremental investment necessary to maintain downstream sector dynamism and growt- is realised2 Indeed t-e &oI can per-aps divert a proportion of t-e plentiful revenue saved .y mar6et reform to provide assistance to $L,s in ma6ing t-ese important infrastructure and capacity additions2
Realistically t-e &oI is unli6ely to ta6e maAor steps towards product mar6et li.eralisation in t-e s-ort3term despite t-e am.itious reform proposed .y t-e Pari6- Report2 Part of t-is policy stasis stems from upward3trending crude prices in late3200/ w-ic- provide policy ma6ers wita -ostile environment for reform2 It is very difficult to em.ar6 on a process of ground.rea6ing mar6et deregulation w-en policy ma6ers fear t-at in doing so t-ey may e9pose economically3 critical and politically3sensitive product mar6ets to a desta.ilising period of increasing glo.al crude prices2 Cowever wit- increases in crude .enc-mar6 prices very li6ely in 2010 as glo.al economic activity recovers t-e conse7uence of maintaining t-e current system of unofficial petroleum product su.sidies will again .e rapidly mounting under3recoveries and a re3emergence of fiscal im.alance in India as t-e &oI is forced into de.t issuance to support $L,s2 'ccording to t-e I('s 200/ Ledium3)erm $il Lar6et Report international crude mar6ets are li6ely to tig-ten considera.ly in t-e medium3term especially in comparison to conditions in t-e aftermat- of t-e glo.al economic slowdown of 200530/205 &iven t-e fiscal situation t-at India currently faces maintaining current product pricing arrangement in t-e medium3term under tig-t oil mar6et conditions and in an environment of -ig- crude prices is entirely unrealistic2 In t-e following years t-e &oI will t-us need to .egin t-oroug- product mar6et reform in order to institutionalise more sustaina.le less costly pricing practices2 It s-ould loo6 to initiate t-is process as soon as possi.le to .ot- ta6e advantage of relatively moderate crude prices currently and to allow Indian consumers an ample period of transition to li.eralised mar6ets2
05
I(' (200/! Ledium3)erm $il Lar6et Report Duly pp2 23@2
Bi.liograp-y
Bas-ma6ov I2 (200@! J(nergy Su.sidies and \Rig-t PricesK in (nergy (fficiency Ool2 @?2 Business Lonitor (200/! India $il and &as Report V@ 200/ Dune2 ,RISI* (2010! Cindustan Petroleum ,orporation *imited4 De.t Instruments and Ban6 ;acilities Danuary2 ,ropper L2 (2001! JPu.lic )ransport and 'fforda.ility in Lum.ai IndiaK #orld Ban6 #or6ing Papers2 ;',)S &lo.al (nergy (200/! 'sia Pacific Refinery ,onfiguration and ,onstruction4 $il Data.oo6 II Oolume 1 'pril2 ;',)S &lo.al (nergy (200/! 'sia3Pacific $il Product Balances $il Data.oo6 III Oolume 1 'pril2 &overnment of India )-e Pari6- ,ommittee (2010! Report of t-e (9pert &roup on a Oia.le and Sustaina.le System of Pricing Petroleum Products ;e.ruary2 &overnment of India Linistry of ;inance (200/! Fnion Budget Key (9cerpts Duly2 &overnment of India Petroleum Planning and 'nalysis ,ell (200/ 2010! $il Prices and )a9es availa.le at www2ppac2org2in2 &overnment of India Planning ,ommission (2000! JPetroleum and %atural &as ,-apterK (levent- ;ive3+ear Plan2 Indian $il P &as (200/! J;urt-er )a9 ,uts on Petrol ProductsMK Ool2 1@ %o2122 International (nergy 'gency (2005! #orld (nergy $utloo6 %ovem.er2 International (nergy 'gency (200/! Ledium3)erm $il Lar6et Report Dune2 International (nergy 'gency (2010! $il Lar6et Report ;e.ruary p2 ?@2 Lorgan )2 (2000! (nergy Su.sidies4 )-eir Lagnitude Cow t-ey 'ffect (nergy Investment and &reen-ouse &as (missions and Prospects for Reform Dune2 $rganisation of Petroleum (9porting ,ountries ($P(,! (200/! #orld $il $utloo62 Platts (200/! JIndia )a6es a ;res- *oo6 at ;uel Pricing Reforms : )-roug- 'nti7ue &lassesK 1 Decem.er2 Standard P Poors (200/! India Sovereign ,redit Rating4 Press Release ;e.ruary2 )-e Cindu (200/! JIndia ,loc6s I2I Percent &rowt- in 20053200/K @0 Lay2 Fnited %ations (conomic ,ommission for (urope (F%(,(! (2002! Reforming (nergy Pricing and Su.sidies4 Part 2 &uidelines for Reforming (nergy Su.sidies &eneva2 Fnited States &overnment (nergy Information 'dministration (200/! India ,ountry Report Larc-2 Fnited States &overnment (nergy Information 'dministration (200/! International (nergy $utloo6 Lay2 Fnited States &overnment (nergy Information 'dministration (200/! S-ort3term (nergy $utloo6 %ovem.er2 Page H I1
Oon Lolt6e '2 ,2 LcKee and )2 Lorgan (2001! (nergy Su.sidies4 *essons learned in 'ssessing t-eir Impact and Designing Policy Reforms Fnited %ations (nvironment Programme2 #all Street Dournal (200I! J&iant $il Refinery in India S-ows ;orces Roiling IndustryK 2/ 'ugust2 Page H I2 #orld Ban6 (2005! #orld Development Report 200/ %ovem.er2
'..reviations
)erm 'PL B.l=d BP,* BP* ,P,* ($Fs ;IPB ;+ &oI CP,* I(P I$,* I$,s *P& L.=d LP%& LPR* L)$LR $L,s P%&RB PP', PSF RBI RI* S(Es S*R SPP Description 'dministrative Pricing Lec-anism Barrels per day B-arat Petroleum ,orporation *imited Below t-e Poverty *ine ,-ennai Petroleum ,orporation *imited (9port3$riented Fnits ;oreign Investment Promotion Board ;iscal +ear &overnment of India Cindustan Petroleum ,orporation *imited Integrated (nergy Policy Indian $il ,orporation *imited International $il ,ompanies *i7uefied petroleum gas Lillion .arrels per day Linistry of Petroleum and %atural &as Langalore Refinery and Petroc-emicals ,orporation *imited Ledium3)erm $il Lar6et Report $il Lar6eting ,ompanies Petroleum and %atural &as Regulatory Board Petroleum Planning and 'nalysis ,ell Pu.lic3Sector Fnderta6ing Reserve Ban6 of India Reliance Industry *imited Special (conomic Eones Statutory *i7uidity Ratio Standard P Poors Page H I@
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2010

Indias Downstream Petroleum Sector

InternatIonal energy agency

I%)(R%')I$%'* (%(R&+ '&(%,+

)-e (uropean ,ommission also participates in t-e wor6 of t-e I('2

Indias Downstream Petroleum Sector

InternatIonal energy agency

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

,-apter 12 (9ecutive summary and introduction1

Indias Downstream Petroleum Sector : < $(,D=I(' 2010 9

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Setting t-e conte9t of t-e study

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

,-apter 22 Petroleum pricing and Jeffective su.sidiesK in India

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

)-e cost of JeffectiveK su.sidies4 under3recoveries to $il Lar6eting ,ompanies

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

,-art @2 S-aring t-e under3recovery (F3R! .urden

Dealing wit- under3recoveries

Rationalisation of ta9es and duties

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

,-art 12 ,entre e9cise vs state sales ta9es

Revenue (Lillions Rs2! ?00000

,ontri.ution to fiscal and macroeconomic insta.ility

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

)a9 )otal F3R $il .onds

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

)-e impact of pricing arrangements on downstream development

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

' pat- to reformM

Linistry of ;inance (200/! Fnion Budget Key (9cerpts I Duly2

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Key policy goals in Indian petroleum refining and retail

,reating an Indian li7uid fuels e9porting -u.

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

'n institutional framewor6 for policy ac-ievement and sectoral growt-M

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Downstream .usiness environment

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

;ostering investment4 Special (conomic Eones (9port3$riented Fnits

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

'ssessing Indias downstream sector regulatory framewor6

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

,-apter 12 Indias oil mar6eting companies

$L,s relations wit- t-e &oI

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Structure of t-e $L, sector

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

Refining (m.=d! Retail outlets Source4 I(' analysis2

(ssar Langalore IN ?N ,-ennai ?N

Source4 I(' analysis2

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

CP,* 21N I$,* ?2N BP,* 21N

Source4 I(' analysis2

' .rief description of Indias t-ree $L,s

Indias Downstream Petroleum Sector : < $(,D=I(' 2010

)-e c-allenge facing $L,s

See (I' (200/! India ,ountry Report p2 12