Indian oil industry: Marketing and pricing

This is the fourth article of a series on development of the Indian oil industry since its inception in 1867. Herein, we shall focus on (i) the oil marketing strategy of Indian companies during 1970-90; and (ii) pricing policies followed by the government for indigenous crude, natural gas and imported crude.

Marketing

Till the 1950s, Burmah Shell, Standard Vacuum (Esso) and Caltex were primarily engaged in the marketing of petroleum products in India. Prior to the establishment of refineries by those companies in the early 1950s, all the products they marketed were imported from their overseas affiliates. From the sixties onwards, Indian Oil Corporation (IOC) got involved in the marketing of oil products. After nationalisation of foreign oil companies, in the seventies, the newly formed PSUs — Bharat Petroleum Corporation Ltd. (BPCL) and Hindustan Petroleum Corporation Ltd. (HPCL) — became integrated refinery cum marketing companies.

In 1965, the government took a major policy decision to permit only the IOC to handle the imports and marketing of refined petroleum products within the country. It was also entrusted with the task of marketing petroleum products of the joint sector refineries — Madras Refinery Ltd. (MRL) and Cochin Refinery Ltd. (CRL). Thus, from a market share of 24% in 1965, IOC's market share rose to 65% in 1975.

Market participants consisted, primarily, of consumers and marketers. Consumers could be divided into following categories. (i) Rural household consumers: They used petroleum products — mainly kerosene — as fuel for illumination. (ii) Urban household consumers: Petroleum products were purchased to run private vehicles and cooking. Motor spirit, kerosene and liquefied petroleum gas (LPG) were the main products consumed. (iii) Transportation sector: Railways, private and state transportation companies, shipping companies, and airlines were the major consumers. High speed diesel (HSD), furnace oil and aviation fuel were primary items of consumption. (iv) Utilities: Electricity companies mainly used furnace oil and natural gas. (v) Industries: Furnace oil, diesel, and natural gas were consumed as fuel. Naphtha and natural gas were used as feedstock in the fertiliser and petrochemical industry. Furnace oil was also used as feedstock in fertiliser production. (vi) Agriculture: Diesel oil was mainly consumed to run pump sets, tractors etc. Clearly, to meet the demands of different market segments, different marketing tactics were required.

Marketing companies could be divided mainly into three different categories. (i) Crude oil was supplied to oil refineries directly from the oilfields of ONGC and OIL. For coastal refineries, which relied on imported crude, IOC was the sole marketing company since the mid-1970s. (ii) For marketing of natural gas, Gas Authority of India (GAIL), a PSU, was formed in August 1984. Prior to the formation of GAIL, ONGC was primarily responsible for the marketing of natural gas through Assam Gas Company — a state government undertaking engaged in marketing and distribution of gas produced in the upper Assam oilfields. In 1987, Gujarat Gas Company Ltd. (CGCL) and Gujarat Industrial Development Corporation were incorporated to execute the Ankleshwar and Bharuch natural gas distribution project. Public sector oil companies marketed and distributed liquefied petroleum gas (LPG). (iii) For the marketing of petroleum products, the government primarily relied on public sector-integrated refining and marketing companies.

After the nationalisation of foreign oil companies, marketing share of major oil companies in 1985-86 were: IOC (Marketing Division) 57.21%, IOC (Assam Oil Division) 1.57%, IBP 3.54%, HPCL 18.74%, BPCL 18.27% and others (private lube companies) 0.67%. Though IOC was the market leader, its share had come down to 57% in 1985 from 65% in 1975. This was a deliberate move by the government to allow higher growth to other smaller PSUs.

The Oil Coordination Committee (OCC) was set up in July 1975. It was an inter-industry committee that looked at crude oil production, its import, transportation, refining throughput, supply planning, distribution, marketing, management of pool funds etc.

As a marketing strategy, OCC had introduced the concept of Sales Plan Estimates (SPEs) and Sales Plan Meeting (SPM) to achieve its objectives. SPE allocated the total annual sales quota for each petroleum marketing company. The marketing pattern of the overall sales plan was worked out by the individual companies and a final product-wise sales plan was agreed upon by them. From SPE, OCC then narrowed its focus to SPM which was conveyed on the 25th or 26th of every month to formulate the supply plan for the entire country for the next month. It was through this micro-level planning that petroleum supply was ensured.

Pricing of crude and natural gas

We shall discuss, in brief, the pricing strategy followed by the oil companies for (a) indigenous crude oil, (b) natural gas and (c) crude imports

Crude oil

From the early 1960s, ONGC started to produce crude oil. The government wanted to have a say in its pricing. In May 1964, the government appointed a Working Group on Oil Prices which submitted its report on August 18, 1965. Its recommendations were implemented from February 1, 1966 with a few modifications. A protective import duty of 20 per cent ad valorem was imposed on crude oil. It was also decided that the price of indigenous crude payable to the producer should not be less than the landed cost (exclusive of the import duty if any) calculated on the basis of the full posted f.o.b. prices (i.e., without discount) of analogous crudes imported from the Middle East.

Until February 1974, the principle of 'import parity' constituted the basis for pricing of indigenous crude. Though the government discarded the 'import parity' principle in 1974, it announced the indigenous crude pricing policy only in 1976. From February 1974, the weighted average price of imported and indigenous crude came into force and crude oil price equalisation (COPE) account was opened. The purpose of the COPE account was to equalise the price of crude oil received from various sources.

Oil Price Committee (OPC) — set up in March 1974 to advise on general principles of pricing policy of petroleum products — submitted its final report in May 1976 which, among other things, suggested that the price of indigenous crude should be based on the long-run social marginal cost of domestic crude. The recommendation was accepted by the government and the base price of crude (long-run social marginal cost) per metric tonne was fixed at Rs 203.41 with respect to onshore and Rs 331.65 for offshore crude from December 16, 1977.

The government raised the base price of crude on an ad hoc basis to Rs 1,021 per metric tonne w.e.f. July 11, 1981, which was unchanged during the period of our study. The government's logic behind this price increase were: under-pricing of domestic crude; the strain on the balance of payment and need for moderating demand for petroleum products; pricing indigenous crude at par with the price paid on imported crude; meeting the rising expense of exploration and development projects undertaken by ONGC and OIL. Thus, the concept of 'import parity' for crude pricing came back again in 1981.

Another committee, oil cost revenue committee (OCRC) — constituted in the early eighties — recommended the continuation of the pool pricing concept of crude.

In the early 1980s, the cost of ONGC crude was substantially less than the base price. At some point in time, the cost of production was one-third of the base price. While the cost of production of onshore crude had risen steeply, the production cost of offshore crude decreased over the years.

To calculate the price of indigenous crude, oil development cess and royalty were added to the basic price of crude fixed by the government. Imported price of crude consisted of f.o.b. price, freight, ocean loss and other auxiliary duties. Finally, the pool price of crude i.e., delivery cost of crude to refineries was arrived at by calculating the weighted average of imported and indigenous price of crude.

Oil development cess (payable to the Central government) and royalty (payable to the state government where oilfields were situated) were added to the base price to arrive at the final indigenous crude price. In 1977, oil development cess and royalty per MT were Rs 60 and Rs 42 respectively. In 1981, the cess was increased to Rs 100 and royalty to Rs 192. The cess was further increased to Rs 600 in 1987. Thus, in March 1987, the final indigenous price of crude was Rs 1,813 per MT (Rs 1,021 + Rs 600 + Rs 192). The international crude price in that year was Rs 1,574.

The Oil Price Committee (OPC) also determined the freight to be charged for crude transportation. From the mid-seventies, as per OPC recommendation, the cost of transportation of crude through pipeline from the central tank to the refinery installation was borne by the refinery. The refinery was entitled to actual operating cost plus a return at 15 per cent on capital employed — subject to norms and utilisation capacity to be stipulated by the government from time to time. For Ocean transportation by Indian tankers, a 'cost plus formula' was used for determining the freight rate. The formula was advised by the World Bank. This pricing technique, which is also used to determine the minimum support price (MSP) for agricultural products, demands further discussion.

In 1972, the World Bank offered USD 85 million loan for 16 years to the Shipping Corporation of India for acquiring oil tankers. The World Bank computed a cost-plus formula for freight determination to ensure a reasonable return on investment from the six tankers financed through the Bank loan. In the mid-seventies, the cost-plus formula received the Indian Government's endorsement for determining freight rate for petroleum tankers. The logic behind the application of cost-plus formula was: the long term dedicated employment of tankers for transportation of petroleum crude and insulation of the owner and the charterer from the volatility in freight rates and the cyclical nature of the industry.

The ship owners were guaranteed a minimum 12 per cent return on equity capital and three per cent on loan capital over and above the rate of interest for the loan regardless of the volatility in crude tanker market price. The cost-plus formula was a bonanza for the crude tanker operators, mainly to SCI at a time when global freight rates on an average were very low.

Natural gas

The natural gas pricing was kept outside the purview of OPC (1976) and OCRC (1984) though the production of gas increased substantially in this period. OIL and ONGC charged different prices in different regions. Moreover, the price of gas varied from industry to industry as well. Few examples:

During the early 1960s, when OIL went into production, the price of gas was kept very low. Gas was supplied at the rate of Rs 8.83 per thousand cu meter to Assam State Electricity Board but it was supplied to a fertiliser company at the rate of Rs 42.38 per thousand cu. mtr. These prices were prevalent till the mid-1970s.

In July 1974, the producer price of OIL gas was raised to Rs 33.31 per thousand cu. mtr. and subsequently to Rs 70.63 per thousand cu. mtr in January 1976. The price charged to the fertiliser corporation was also raised to Rs 150.06 per thousand cu. mtr. In 1978, the government recommended a price of Rs 250 per thousand cu. mtr. for the gas produced by OIL. The price was determined on the basis of (i) the distribution of total cost between crude oil and natural gas sectors. (ii) Post-tax return of 12 per cent on capital employed.

For ONGC gas in the Gujarat region, the VKRV Rao Committee (1964) recommended a price of Rs 50 per thousand cu. mtr. In the subsequent period, the price was revised a number of times. At the end of 1982-83, the price varied from Rs 11 per thousand cu. mtr. for a milk-producing company to Rs 867 for electricity generation and to a maximum of Rs 2,492 for a heavy water project.

In the same period, ONGC charged Rs 99 per thousand cu. mtr. for gas supplied to Assam State Electricity Board and Rs 694.4 per thousand cu. mtr. for industrial use in Assam.

In 1982, the price of offshore gas in the Bombay region varied from Rs 435 per thousand cu. mtr. (for energy production) to Rs 3,051 per thousand cu. mtr. for feedstock (fertiliser, petrochemicals etc.).

Thus, in India, gas was supplied even in early to the mid-eighties to different consumers of different regions at prices which ranged from Rs 99 per thousand cu. mtr. to Rs 3,051 per thousand cu. mtr.

In the absence of a uniform set of prices, gas producing companies (OIL and ONGC) had to negotiate the terms which often resulted in disputes. In Gujarat alone, as many as 28 industries in 1986 went to court against the price demanded by the ONGC. Few users even refused to pay the producers.

Ultimately, in 1987, the government announced the uniform price of natural gas as follows: (i) for offshore gas at landfall and onshore gas, Rs 1,400 per thousand cu. mtr. (ii) for gas sold along with HBJ pipeline, Rs 2,250 per thousand cu. mtr. (iii) for gas sold in Northeastern states, Rs 1,000 per thousand cu. mtr with a provision for discount of up to Rs 500 per thousand cu. mtr in individual cases.

Though natural gas, worldwide, took an increasingly important role in energy consumption and management, the Government of India till mid 1980s could not formulate any marketing policy for the same. A substantial amount of gas was flared. Even at the end of 1989, 30% of the produced gas could not be utilised, hence flared. In 1970-71, more than 50% of natural gas produced in India was flared.

Imported crude

From 11,665 thousand tonnes in 1970, crude imports increased to 18,919 thousand tonnes in 1989. The correlation (0.53) between import price of crude paid by the government and quantity imported between 1970 and 89 was highly positive. Imports increased when prices had risen and vice versa. The main reasons for this could be lack of storage capacity, inadequate foreign exchange to the importing agency and the decision to import at any cost to keep the supply of crude uninterrupted.

During 1970-89, the following developments took place in the Indian crude imports: (i) The USSR had lost its predominant position in crude oil supplies to India. (ii) During the crisis period (1973 to 1979) foreign oil companies supplied oil reportedly at a cheaper rate than the government's purchase. (iii) The government diversified the source of crude oil supply. (iv) The US oil companies were major suppliers to joint sector refineries (MRL, CRL) and HPCL. (v) The Anglo-Dutch major, Burmah Shell, had lost their Indian account.

A detailed study by this author revealed that India had successfully managed to arrange crude supply during the crisis period, mainly through bilateral agreements with oil-rich developing countries. The source of oil was diversified over the years. Moreover, cordial relations with those countries boosted India's exports and opened employment opportunities for millions of Indians. Most importantly, through arrangements with national oil companies, India got out of the grip of the cartels of oil TNCs which dominated crude supplies for years. However, the price paid by the Government of India over years in importing crude was higher than the average OPEC price. In all

the years from 1981 to 1989, the spot

price of crude was much lower. Had the government opted for spot price or negotiated with the long-term suppliers on the basis of spot market price, a discount of up to Rs 450.06 per tonne could be obtained. In the years of glut, the government ended up paying as high as nearly 46% in excess (in 1986) of the prevailing spot price of crude. The price of imported crude, mainly from friendly countries, had proved costly.

In the next article, we shall discuss how the pricing strategy followed by the government for petroleum products has made India hugely dependent on petroleum, not only for fuel but also for food supplies.

Views expressed are personal