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D Lilly, Director (Finance), Chennai Petroleum Corporation Limited (CPCL)

08 Feb 2012

Chennai Petroleum Corporation Limited (CPCL) is a subsidiary of Indian Oil Corporation (IOC). It is the only own source refinery of IOC in South India with a total refining capacity of 11.5 MMTPA. It has two refineries located in Tamil Nadu - the first refinery at Chennai with a capacity of 10.5 MMTPA and the second refinery at Cauvery Basin (CBR) near Nagapattinam with a capacity of 1.0 MMTPA.

D Lilly, Director (Finance), CPCL in a conversation with InfralineEnergy's Sangeeta Tanwar talks about impact of possible sanctions against crude oil supplier Iran along with the likely impact of devaluation of Rupee on Indian refineries. She also talks about CPCL's ambitious plans of enhancing capacity of its refinery and shares company's plans to invest Rs 3, 570 crore in the 12th Five Year Plan (FYP).

Edited excerpts.

How do you see possible sanctions on Iran affecting crude supply to Indian refineries?

The share of Iranian crude in CPCL's oil import basket is hardly three percent. If need be we can always shift that quantity to some other crude. Therefore, CPCL is not going to be affected by unfavourable developments, if any, affecting Iran. However, as far as the country as a whole is concerned, there is going to be some kind of impact. But even in that eventuality, there can be a fallback arrangement whereby the crude oil requirement can be shifted to other sources. Therefore, we can say that in the short-term the Iran crisis is going to upset the existing crude oil arrangement that the country has in place. However, in medium-term and in the long-term any crisis involving Iran may not affect us. Besides, over a period of time all the refineries have diversified their sources of crude oil.

What is the kind of impact that sliding Rupee is having on the refineries?

Our first and foremost concern is the rising interest cost itself. Our second concern is the fluctuating exchange rate. To a large extent, the impact of exchange rate on the accounts is due to valuation of open liability for foreign currency loans on Mark to market basis on the last day of the accounting period. Since the exchange rate may not be the same, when the loan is actually repaid, the impact shown in the accounts, again to a large extent, is notional.

"As far as the volume of jet fuel handled by Indian refiners is concerned, it is not much to affect the profits. For instance the ATF volume is very small, in the range of five to seven percent in CPCL. But, the pricing of ATF is better than the other alternative fuel that we have i.e., kerosene. So to that extent there could be some kind of impact."

Another thing is that our foreign currency loans as of today are basically PCFC loans and are backed by exports. Thus there is a natural hedging available to a large extent. However, the difference in exchange rate at the time of repayment of loan and at the time of export realisation may give rise to a delta plus or minus. But that delta plus or minus as such may not be sizeable to create a serious concern. Besides, when you look at a quarterly balance sheet, say for instance September or December Quarter, owing to time lag between Mark to market valuation, export realization and repayment, you may find a negative or positive impact on the accounts of that particular Quarter, which will offset each other eventually.

What is going to be the short-term and long-term movement of crude oil prices?

We are expecting the crude oil prices to stay within a band of US$90/bbl to US$110/bbl in the long term. All the pointers and developments are indicating towards that. Whenever there is some kind of upsets in the global market, be it the Euro crisis or possible talks of sanctions to be imposed on Iran - in the short-term, oil prices tend to go-up. But in the long-term crude oil prices will settle around US$105-106/bbl to reach equilibrium. Even in the time of the unexpected global catastrophes, the price movement exhibited by crude oil is not very steep. The prices moved within a band.

Private airlines in the country have been allowed to import ATF. What impact is this move going to have on revenues earned by Indian refineries?

As far as the volume of jet fuel handled by Indian refiners is concerned, it is not much to affect the profits. For instance the ATF volume is very small, in the range of five to seven percent in CPCL. But, the pricing of ATF is better than the other alternative fuel that we have i.e., kerosene. So to that extent there could be some kind of impact. But I expect that the impact may not be sizable. Also, if there is fall in demand in ATF, the same may end up as kerosene, for which we have good enough demand.

"Exchange rate fluctuation, contraction in Singapore margin coupled with high interest cost is going to hit our bottom line. As of now we are not having a positive outlook for robust GRM. "

Further, the airlines importing ATF need to take care the infrastructure and other modalities which is going to take some time.

What is the kind of Gross Refining Margin (GRMs) that CPCL expecting this year?

Refining business is basically dollar dominated. The prices for both the crude oil and products are based on international quote. Once the dollar denomination is available on both the sides and is converted into Rupee, the exchange rate fluctuations are automatically factored in. There is however, time lag between actual payment for crude, pricing period and the sales realization. While the payment for crude is based on the exchange rate as applicable on the date of payment, the pricing for the product is based on the average international quotes and exchange rate for a period of 15 days or 30 days depending upon the product. Thus there are impacts arising out of time lag and averaging effect. If you look at it from the long-term perspective and as a "going concern" there is no issue, but in the short term it's going to have an impact on every quarter. There will be some plus or minus impact in the accounts of each quarter which we will offset each other on overall basis.

Considering the general economic scenario we are not going to have the kind of positive GRM that we enjoyed last year. Today everybody is talking about a contraction in the Spread in Singapore market. It has already contracted by US$ three to five per barrel or so in the last week of November. This kind of impact may not last up to March but it's just an indication of things to come for the refining sector. So there is contraction happening in the margin itself and this very contraction will be reflected here as well. Plus the other factors like fluctuation in exchange rate is also going to have an impact on GRMs. If exchange rate continues to depreciate it will further complicate matters. Exchange rate fluctuation, contraction in Singapore margin coupled with high interest cost is going to hit our bottom line. As of now we are not having a positive outlook for robust GRM.

Is cost plus approach a better option for pricing of petroleum products in the country. How does cost plus approach pricing compare with international market determined pricing?

The Administered Price Mechanism (APM) was completely dismantled way back in 2002. A number of expert committees at various points of time looked into options available for pricing petroleum products at the country level. It was decided that the cost plus mechanism was not a suitable methodology. The pricing mechanism was recommended to be on the basis of import parity or trade parity so as to reflect international fuel prices. This was decided because the country is dependent on the crude oil import to the extent of 80 to 85 percent.

"The proposal is likely to be revised as 6 MMTPA brownfield refinery. Depending upon the configuration planned for this proposed 6 MMTPA refinery, the cost is estimated to be anywhere between Rs 10,000 crore to 13,000 crore. Once the final configuration for the refinery is arrived at, we will carry out a feasibility report and take further call on our funding pattern."

With major share of crude oil being purchased at international market rate, if the petroleum product pricing was to follow the cost plus approach, the consumer is directly affected by the fluctuation in not only the crude prices but also on account of exchange fluctuation. It was for this very reason that the committees headed by Shri C Rangarajan and Shri Chaturvedi and other industry experts discounted the cost plus approach.

CPCL is planning to set up a brown-field nine MMTPA Refinery to replace the Refinery-I unit (2.8 MMTPA) at Manali with a project cost estimates of about Rs 14,000 crore. How is CPCL planning to fund this project? What is the current status of the project and which location has been finalised for the project?

There is a correction here. We had originally planned for a nine MMTPA refinery. When we placed the proposal for approval, there were some suggestions to relook in to the proposal of replacing the Refinery -1 considering the available economic life of the Refinery and optimizing the investment. Therefore, we are reworking the proposal. The proposal is likely to be revised as 6 MMTPA brownfield refinery. Depending upon the configuration planned for this proposed 6 MMTPA refinery, the cost is estimated to be anywhere between Rs 10,000 crore to 13,000 crore. Once the final configuration for the refinery is arrived at, we will carry out a feasibility report and take further call on our funding pattern. We are looking at both debt and equity option as financing model for the refinery. The refinery is going to be in Manali region only. It's going to come-up at an adjacent land which is two to three km away from existing location.

CPCL has struck an agreement with the Karaikkal Port for bringing in bigger vessels with crude supplies to the CBR. How is the move going to increase refinery's utilisation levels?

CBR was originally designed to process local crude available in the region. The CBR's capacity was enhanced from 0.5 MMTPA to 1 MMTPA considering the crude availability from PY-3 / 1 oil fields. We also created a jetty to handle crude received thru tankers from PY-3/ 1 fields. But then, the crude availability from these sources drastically reduced over a period of time. Subsequently, we started getting crude oil in small quantity from KG-D6 fields also. Since the present draft at the oil jetty is not adequate to berth bigger tankers, by connecting CBR to the the Karaikkal Port we can plan for  bigger size tankers to transport comparatively large volume of crude oil from other fields and also to receive import parcels if proved economical. With the facility available to berth bigger tankers, we hope to increase the throughput of CBR in due course.

What is the kind of investment that CPCL has made in connecting its refinery to Karaikkal port?

Laying pipeline for connecting Karaikkal port is costing us Rs 10 crore approx. We are required to invest another Rs 25 crore in tankage facility to take care of increased storage requirement of bigger parcel. Besides this we will have to bear the normal crude and freight cost. With our parcel size becoming bigger, the per MT cost will be lesser owing to scale economies.

What are the potential risks identified by CPCL with its existing 30" pipeline from Chennai to Manali?

As such when people talk about risk, it's because the pipeline is 46 years old. While the age of the pipeline is a given fact, we do take steps to maintain the health of the line thru periodical maintenance checks, repairs, third party inspections etc. Recently, we have engaged Engineers India Limited to undertake independent analysis of the health and safety of the pipeline. The old pipeline however has a shortcoming since the pumping pressure becomes a limiting factor.

What are the steps being taken by you to further increase the refinery's efficiency?

The complexity factor of CPCL is high as compared to other refineries because the refinery  produces not only bulk fuels but also petro chemical feed stock, lubes, wax and special products like Hexane etc.  Multiple processes for wide array of products have got its own complications and make our maneuvering capacity restricted. We are addressing this challenge by adopting whatever methods we can for enhancing our flexibility. For example there is a continuous effort to broad base our crude basket by sourcing crude from diverse sources. CPCL is working continuously towards addressing the twin challenge of complexity and flexibility.

What are the other policy issues that are a concern with Indian refineries?

Certain policy changes like the recent development of private airlines importing ATF fuel do have an impact on the refining sector as such. It may not have a huge impact on CPCL given that ATF volumes are very low. But it certainly will affect our bottomline. Now we are talking about concern regarding limitation on sulphur content in furnace oil. This is again going to have an impact on our furnace oil export. We will have to incur cost for matching-up the required specifications. Though it remains to be seen by how much the premium or discount that we are enjoying may come-up or go down depending upon CPCL meeting prescribed specifications.

CPCL has ventured into renewable energy. What is the potential benefit that you expect by registering renewable projects under Clean Development Mechanism (CDM)? What is the projected investment that the company plans to make into wind and solar energy in next five years?

We already have 17.7 MW wind farm in Pushpathur village near Coimbatore. We take pride in the fact that we were the first one in oil industry to enter in to wind energy sector. Earlier we were selling this energy to the TN grid. But two years back we opted for wheeling the energy, which means that we load this energy at Pushpathur and get the equivalent energy for our desalination plant near Manali. This arrangement not only helps in getting the energy from our own source but also provides avenue for availing benefits under CDM.

"Analysts' topmost concern relates to contracting GRMs and secondly the effects of global happenings on the domestic industry. This is so because the country is predominately dependent on international market for crude and export of its crude oil products."

As per our expectation, as part of this arrangement, we are to get 34,000 CER. We are already in the process of getting this project registered under CDM. In addition, we are considering 35 MW wind energy generation as well. We are looking at this purely on economic basis and it may also meet the RPO requirement which is coming-up as a statutory requirement.

What is CPCL's total outlay as part of the 12th FYP?

The 12th FYP outlay is projected as Rs 3,570 crore. A major part of this investment is for the Residue upgradation project. The investment on this alone will be  Rs 3040 crore. The balance of Rs 500 crore is towards CDU Revamp project, left over Euro IV offsite facilities and the new crude oil pipeline. We have also considered an outlay of Rs 120 crore for the DFR study for the 6MMTPA refinery.

With frequent hike in interest rate by RBI, the capital cost is set to go up with debt becoming more expensive. In such circumstances, what are the alternative sources of raising funds for CPCL's planned investments?

We are looking at ECB option for financing our planned projects. Our credit rating is quite good. We enjoy triple A rating. Our track record of 46 years of unblemished performance gives us leverage while arranging funds for our projects. We are pursuing a judicious mix of long-term foreign currency and the INR borrowings. Our first attempt is to arrange for funds in-house and then look for external sources of arranging funds.

What is the topmost concern of analysts and observers tracking refinery sector?

Analysts' topmost concern relates to contracting GRMs and secondly the effects of global happenings on the domestic industry. This is so because the country is predominately dependent on international market for crude and export of its crude oil products. On the domestic front, market watchers express concern on pricing of petroleum products and government policy issues.

The other issue that analysts look at it is the future growth we are planning for. As is the case with other businesses, our calculations of future demand and supply is not only based on our own assessment but other person's reading of that supply and demand as well. If we say that the capacity will increase to x level and we also factor in our capacity enhancements in that projection but if globally capacities committed are either not materialising from somebody else's end then it's a matter of concern.

(InfralineEnergy thanks D Lilly, Director (Finance) Chennai Petroleum Corporation Limited (CPCL) for sharing her 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 happening in the Indian energy sector.)