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N C Sridharan, Director (Finance), Chennai Petroleum Corporation Limited (CPCL)

12 May 2011

Chennai Petroleum Corporation Limited (CPCL) is a subsidiary of Indian Oil Corporation (IOC). It is the largest refinery in South India with a total refining capacity of 10.5 MMTPA. CPCL has two refineries located in Tamil Nadu - the first refinery at Chennai with a capacity of 9.5 MMTPA and the second refinery at Cauvery Basin near Nagapattinam with a capacity of 1.0 MMTPA.

Sridharan, in a conversation with InfralineEnergy's Sangeeta Tanwar speaks about volatility in crude oil prices, challenges faced by Indian refineries with rising operating costs and CPCL's expansion plans.

Edited Excerpts

Owing to volatility in oil prices, do you think the share of liquid fuels of Indian market consumption is likely to go down?
The volatility seen in oil prices will not affect the liquid fuels share in Indian market. In 2010-11, the prices rose continuously except a brief period in the second quarter. Even with increase in prices of oil, the consumption too has been increasing. The statistics for April to February 2011 reveal that MS (motor spirit) rose by 10 percent over previous year's consumption, ATF (aviation turbine fuel) and diesel rose by 10 percent and seven percent, respectively over previous year's consumption.
Is there any chance of prices coming down?

Petroleum being a worldwide commodity - its demand would be influenced by the country's growth as well as worldwide economic growth of various economies such as US, UK, Japan, China and other countries. Moreover, the country's per capita consumption too is likely to go up resulting in high demand for liquid fuels.

"As far as the fundamentals are considered, nobody in the business is ready to do a grass root refinery."

However, in future the volatility in oil prices and the country achieving a target of 260 MMTPA will definitely result in bringing down the petrol price level fundamentally.

With high demand for petroleum products, how much investment is expected to come in the Indian refi ning sector in the next five years?

Even in next fi ve years, no new refi nery is likely to come up in India. Though, there can be some de-bottlenecking projects and slight capacity expansion.Mangalore Refi nery and Petrochemicals Limited would expand from 14 to 18 MMTPA. Essar Oil plans to expand upto 18 MMTPA. Then Bharat Petroleum Corporation Limited refi nery is going for further de-bottlenecking. CPCL itself is going to do a nine MMTPA refinery and then scrap the existing unit of three MMTPA refinery.This will result in a net addition of six MMTPA.

As far as the fundamentals are considered, nobody in the business is ready to do a grassroot refi nery. This is so because BORL’s (Bharat Oman Refi neries) Bina refi nery in Madhya Pradesh has been just commissioned. Hindustan Petroleum Corporation Limited’s Bhatinda refi nery and IOC’s Paradip refi nery in Orissa are expected to come up by December this year. All these units are going to come up this year along with other de-bottlenecking facilities.

The total refi ning capacity in India is expected to reach about 260 MMTPA by 2011-12. Are we on course to meet this target?

The target of 260 MMTPA cannot be achieved by 2011. We can meet the projected capacities only by 2013-14. All of the projects envisaged are unlikely to fall in place. For example CPCL refinery is going to come up much later by 2014. We can safely look at achieving a capacity to the tune of 240 MMTPA by 2011-12.

Having said that, we evacuate about one-third of the products for export. With a total production of 180 million tonne, our consumption is 130 million tonne. We are exporting, therefore, around 50 million tonne.

Even with our capacity going up to 240 MMTPA, our demand is expected to be around 160 MMTPA. There will still be a gap of 80 MMTPA between production and consumption. It is with this kind of backdrop that we need to view how additional capacities can further be created.

India accounts for nearly four percent of the global refining capacity and fast emerging as a major refining hub in Asia-Pacific region. What are the factors responsible for such a development?

As far as the growth of Indian refi ning sector is concerned, the whole story is related to overall performance of the economy. The good news for the refi ning sector is that our GDP growth is good and the economy is quite buoyant. Both these factors are driving consumption.

"The refineries all over the country have spent an amount of Rs 30,000 crore on EURO III and EURO IV upgrades. This money is not being compensated in the pricing mechanism in full."

It was a decade ago that we set our mission to have new refineries independent of what the demand situation at the time was because the idea was to keep public sector plans ahead of the market. This was being done with an aim to create facility in time so that the consumption could catch up in due time.

The plants that were laid in 2000 are now set to fructify and in the meanwhile private sector refi neries are also joining the bandwagon.

What are the challenges faced by the refining industry?

There are three main challenges faced by refi ning industry in the country. The fi rst concern is the custom duty mark-up for refined products coming down and getting narrower. The mark-up (duty differential between crude and oil)used to be around three and half percent. Over the past fi ve years and successive budgets has brought it down to 0.75 cents or so. And this translates to a loss of about US$2.5. This is substantial money for the standalone refinery.

"In retail, the private players couldn’t compete with the omnipresence of PSUs like HPCL, BPCL and Indian Oil Corporation Limited."

Secondly, the refi neries have upgraded to be Euro III and Euro IV compliant. Both these upgrades have happened over the past three years. The refi neries all over the country have spent an amount of Rs 30,000 crore on these upgrades. This money is not being compensated in the pricing mechanism in full. The compensation pattern is very low in comparison to the investments made.

The third challenge is the rise in operating costs for refineries. With more and more units becoming older, it requires more repairs and maintenance leading to high expenditure. As the units get older the turnaround time for various processes such as catalyst and conversion also increases substantially. On an average with four-year turn around cycle, it involves a lot of money.

Another most important discomforting issue faced by refineries and especially those run by public sector companies is the fat salary bill which adds to the burden. Once in every decade, there is a pay committee revision and other issues such as settlement with employees’ union. These things are causing lot of weight into the operating cost for Indian refineries.

The interest rate now is showing a high growth since the concept of base building is coming into effect. Earlier, we were drawing at least two and half per cent lower than the current base rate. Now the base rate system has put further pressure on a refi nery while borrowing especially when crude prices are going up from US$60 per barrel to a price band between US$100 to US$120 per barrel.

What are the policy changes and practices required to further aid the growth of refi ning sector?

The duty protection comfort can be restored to provide comfort to the industry. At present 27 percent of the products suffer 0 percent duty, whereas for crude we have to pay five percent duty. This five percent input duty on crude is not being compensated on full with 27 percent product getting away with 0 percent duty.

There can be an element of enhancement of custom duty markup in other products. One could also look at offering better compensation value for the Euro III and Euro IV products.

Lastly, the company’s management should be more frugal. The maintenance undertaken by refi neries has to be preventive maintenance rather than emergency upsets and shut downs. People should be geared to anticipate in advance. As regards chemicals, catalysts there should be purchased after more bargaining and negotiations.

Why Indian refining industry does not have a single private marketer?

You have to have a huge presence if you want to be in a retail market. The private refi neries started off with this, but down the line the huge infrastructure cost coupled with the end price being capped on four major products - diesel, LPG, kerosene and MS did not allow the private refi neries to advance further. In retail, the private players couldn’t compete with the omnipresence of PSUs like HPCL, BPCL and Indian Oil Corporation Limited. The consumer psyche also played its bit in consumers sticking to PSU brands.

At present CPCL has an installed capacity of 11.5 MMTPA. What are the short-term and long-term expansion plans for further increasing your existing capacity at Manali and Nagapattinam plant?

Our short-term plans include de-bottlenecking of one of the crude distillation units at Nagapattinam by another 6 MMTPA. The project will be completed in the next 12 months.

"Barring the planned nine MMTPA refinery expansion project, the other project costs can be met by internal borrowing and accruals, provided that we get a minimum of US$5 to 5.5 per barrel in four to five years."

The long-term plan includes commissioning a new nine MMTPA refinery at Manali Refi nery and then dismantling the existing three MMTPA refinery unit which was set up in 1969

What are the investment planned for the proposed projects?

The residue upgradation project at Manali refinery is an on-going project undertaken at a cost of Rs 3,200 crore to be spent over a period of 36 to 42 months. This will improve the bottoms by eight to ten percent with bottoms getting into middle diesel pole. Currently we are at 70 percent distill band. This will go up to 78 percent post the residue upgradation project, which will also have a token unit in place.

The de-bottlenecking of unit by 0.6 million tonne should cost us Rs 350 crore. Then there will be usual yearly capital expenditure on the ongoing basis of Rs 200 crore. We have an unspent amount of Rs 800 crore for Euro IV project to be utilised in 2011-12.

Barring the planned nine MMTPA refi nery expansion project, the other project costs can be met by internal borrowing and accruals, provided that we get a minimum of US$5 to 5.5 per barrel in four to fi ve years. Our nine MMTPA refi nery will require investment and have a bearing on previous network that has been generated based on the internal accruals. Accordingly, we will take a call on funding options for the project.

How do you plan to improve your gross margin revenue?

The residue upgradation project will give us additional gross margin of US$2. And reduction in operating costs will give us some cents which is quite external.

In case of custom duty mark up protection is restored to the pre-revision l evel, we can get another 80 cents or so. Diesel, LPG (liquefi ed petroleum gas), ATF do not bear duty mark-up, so we are selling the three at below market price.

(InfralineEnergy thanks N C Sridharan, Director (Finance), CPCL for sharing his valuable insights with our readers. The column ‘In Conversation’, is a platform to engage experts from various sectors to share their views on the different transformations in the Indian energy sector.)