HPCL has ambitious expansion plans to ramp up its production from 17 MMTPA to 42 MMTPA over the next six years. Mukherjee in an interaction with InfralineEnergy's Sangeeta Tanwar shares the public sector refinery's planned investments to the tune of Rs 45,000 crore, a major part of which would be spent on the company's proposed green field refinery project at Ratnagiri.
He also explains the issue of under-recoveries and underlines that with skillful hedging and strong treasury measures, the public sector refineries including HPCL were able to deliver healthy gross revenue margin (GRMs) over the past one year.
Increasingly the countries are losing faith in US$, what impact would this have on oil prices?
Faith in US$ is not going to have any effect on buying and selling of crude oil. It's the price of crude oil that is a matter of concern.
For crude oil it's not the currency in which we trade that is much of a concern rather it's the price of crude oil itself that is a matter of concern. Moreover, as far as our operations are concerned, we borrow US$, Euro and Yen. There is a system by which we appoint an arranger and the arranger helps us to opt for the cheapest mode available at a given point of time.
With high crude oil prices - how well are public sector (PSU) refineries managing their GRMs?
In the past one year the crude oil prices have gone up, but fortunately at the same time, the gradient is also low. With low gradient and the gradual increase of crude oil prices, the spreads also move up. Thus, in the recent past, the spreads for refineries have been very good and accordingly the refineries are making much better GRMs. Therefore, for the refineries, it is the crude oil volatility that is more of a concern than the crude oil prices per se.
"As far as I'm concerned I have to get compensation either from market, upstream discount, government subsidy or a combination of all the three."
The past six months have been good for almost all the refineries including HPCL which has delivered healthy GRMs. For HPCL, the GRMs have been in the order of US$ seven to eight per barrel. We benchmark it with Singapore and it has been at par with Singapore. Our new refinery at Bhatinda would be surpassing Singapore benchmark, as it would deliver six plus GRM because of high complexity and the ability to process much heavier crudes. Also, there are no bottomline issues with the Bhatinda refinery.
What is the biggest challenge facing refinery sector?
The biggest concern for the refineries is the issue of under-recoveries because public sector refineries cannot sell majority of their products at a particular level of price. The crude price lends a level of price for petrol, diesel, LPG and kerosene, but that is not the price that the public sector refineries are able to generate for these products. Therefore, there is an under-recovery issue and its compensation which is again linked with crude oil prices.
How has been the delay in deregulation of diesel prices affecting oil marketing companies? What is going to be the likely impact of government's move to deregulate LPG prices?
It was last year in June that the government made an announcement to the effect that in principle petrol stands deregulated fully. Diesel was also in principle deregulated, but the decision to do so was held back. There are now talks of doing away with direct subsidy in LPG with suggestions such as subsidy being extended to only x number of cylinders and so on. We will see and evaluate changes as they come along. As of now, prices for diesel, kerosene and LPG continue to be controlled.
One third of the under-recoveries are compensated by upstream discount and the balance is substantially covered through government subsidy. This arrangement will continue till the time prices for these products are decontrolled.
To what extent has deregulation of petrol prices helped the public sector refineries in addressing the issue of under-recoveries?
Petrol is not a high volume product. It is a sensitive product for urban population. Since the volume for the product is relatively low, it's not very important when you take the consumption for the whole country, given that petrol prices have gone up from time to time.
"If need be and in case I come under pressure, then I can sell oil bonds that I possess. All these measures are a part of the treasury management and we do have a very strong treasury management in place to handle such a crisis."
Essentially, diesel, kerosene and LPG are high volume products and thus have greater bearing for refineries.
How do you address the issue of under-recoveries?
As far as I'm concerned I have to get compensation either from market, upstream discount, government subsidy or a combination of all the three. Whatever comes from retail (market) comes from the market immediately. One third comes from upstream discount on daily basis, so whenever I pay to upstream company it gives me a discount. This leaves me with only two-third of the under-recovery. Even if I have to bear 10-15 percent of this, more than 50 percent comes by way of subsidy. At most there could be a delay of six months but then we remind ourselves that there are companies which have to earn their revenue on credit on six months basis whereas I get it as compensation.
How real and big is the liquidity crunch faced by public sector refineries? What is HPCL's approach to overcome it?
More than profitability, my problem sometimes is related to liquidity. Because when there is a delay in awarding the compensation, one has to borrow, which gets costlier by the day.
If need be and in case I come under pressure, then I can sell oil bonds that I possess. All these measures are a part of the treasury management and we do have a very strong treasury management in place to handle such a crisis. For example, the interest cost is still the lowest among the oil companies and that's the benchmark.
We try and maximise our gains from one third of the marketing which is not price controlled by the government. Also, we are doing very well in product categories, where margins are very high.
"In the next six to eight months, the long-term sourcing of funds will be external commercial borrowings. It could be in the form of term loans or US$ bonds because they are still cheap."
In 2009-10, HPCL made Rs 1,300 crore, which is low compared to a turnover of 12,500 crore. This sort of comparison does not make any sense because turnover consists of 40-45 percent as taxes. If you see return on capital employed (ROCE) you will find that a return of about 13-14 percent post tax makes for a good ROCE.
There is a lot of cost optimisation exercise that is undertaken on regular basis. We have cross functional teams throughout the organisation who undertake cost optimisation drive. We have teams that report to the board of the company on quarterly basis. The board regularly reviews the progress made. First of all, the margins are very low, because 90 to 96 percent of the cost for the refineries is raw material i.e. crude cost. Out of this, whatever three or four percent that can be saved we try and save that.
With recent 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 your planned investments?
Indian rupee is very costly, it's a matter of fact. Essentially, we are still looking at money abroad. In the next six to eight months, the long-term sourcing of funds will be external commercial borrowings. It could be in the form of term loans or US$ bonds because they are still cheap. With an intelligent and good hedging policy, I think rates are not very high. The rates of borrowing money from foreign countries could be as low as five percent to six percent.
"I feel last year in June something significant happened when the government increased the kerosene prices because everybody thought of kerosene as a holy cow which nobody would touch.."
Also it was about a year ago that we issued two trenches of Indian rupee debentures. So, those options can also be explored though we are not thinking about it as of now. I will have to still borrow the Indian rupee for the short- term borrowing and this can be managed easily.
What is the topmost concern of analysts and observers tracking refinery sector?
Analysts perceive refinery business from a single point of view and that is under-recoveries. Everybody is bullish on crude and therefore they are also bullish on GRMs. In the past six to eight months, the refineries are experiencing healthy GRMs, but the issue of under-recoveries continues.
I feel last year in June something significant happened when the government increased the kerosene prices because everybody thought of kerosene as a holy cow which nobody would touch. But the government came out and increased the prices and proved that was not the case.
HPCL plans to set-up a 9-15MMTPA refinery at Ratnagiri coast. However, the Ratnagiri port is not suitable for big cargo ships as is the case with the Mumbai port or JNPT. How are you addressing this issue?
I believe there is enough draft at Ratnagiri to support heavy cargo ships. I don't have much technical details on that except that we are right now talking to the state government and the Maharashtra Industrial Development Corporation (MIDC) for getting land for the proposed refinery. I will be happy if the required land could be through by the end of this year.
Since allotment of land and other formalities are still in the process we are more focused on Vizag refinery. Ratnagiri would take second lead after Vizag refinery because Vizag refinery is ready. Also, Mumbai refinery continues so it's not that we are in a hurry on the Ratnagiri project.
We want to continue taking out regular products from Mumbai refinery for two reasons. The first objective is to ease out the refinery since it's very cramped within and there are safety issues. Also, over the years the city has grown tremendously adding pressure on the surrounding environment as well.
"The geographical anomalies are there and therefore there are huge purchases and huge sales between all the three companies on overall all India basis."
Secondly, Mumbai refinery could be converted into specialties refinery where it can easily absorb the portion of the Bombay Brihanmumbai Municipal Corporation (BMC) octroi which is a major issue now. With US$1.8 per barrel, the octroi is a major issue with conventional product though it's not that big an issue or a concern with specialty products because there the margins are high.
For example, our lube refinery should continue in Mumbai. One must also remember that with our sights on Ratnagiri project, it's not that we will be getting out more products from the refinery because products are coming out of the Mumbai refinery as well. The little longer focus on setting up the green field refinery project is because it would be expandable. As regards to new refinery, we are talking about plans, environmental issues and little longer steps. Well, six years is a long-time for the strategy to work up to.
We have constructed BHEL-Bhatinda refinery essentially in 39 months time and this gives us lot of confidence that we are capable of constructing a refinery or expanding a refinery in a much shorter period.
How do you see the upcoming BHEL/HMEL-Bhatinda refinery complementing HPCL's existing business?
I have a gap of nine MMTPA between sales and production. At present, HPCL markets around 26 MMTPA of petroleum products, whereas it produces nearly 17 MMTPA. For instance, there is a large gap in supply and demand in North India, which is a major customer. The Mundra -Delhi product pipeline has helped largely in bridging this gap.
"There is no doubt that slowly and steadily LPG is getting replaced. But it's a very long-term process. We will keep our eyes open and accordingly go ahead with opportunities and projects suggesting a good yield."
But having a refinery in Bhatinda itself would make the process of catering to the market in North India far easier. We have already constructed the product pipeline from Bhatinda to Bahadurgarh because Bahadurgarh is a hub near Delhi. And this will help us in making the product available to western UP northwards.
Today between IOC (Indian Oil Corporation), Bharat Petroleum Corporation Limited (BPCL) and HPCL, there is only a product interchange/exchange on turn to turn basis. The geographical anomalies are there and therefore there is huge purchases and huge sales between all the three companies on overall all India basis.
Also, nobody is giving anything to anybody else. Therefore, if I have to provide or make my product available in the market, then I have to arrange it from my supplies. In order to bridge the gap between my sales and production to meet my demand, I'm buying from Essar, Reliance, and Mangalore Refinery and Petrochemicals Limited (MRPL). And this will continue in future as well but HPCL's dependency on other refineries for products will substantially come down with the BHEL/HMEL-Bhatinda refinery coming in.
What is HPCL's market share in different product categories? What are your plans to increase your market share in each of these categories?
HPCL's overall market share is a little less than 20 percent. In retail, we have got a larger market share of about 24 percent. In non-domestic LPG, we are market leader with 42 percent share. Another category that's big for us is lubricants, where again we command a share of 25 percent. Lubricant as a product category has proved to be a highly successful story for us.
It is a high margin product. We call it two percent volume and 15 percent by profit contribution. We give Castrol a run for their money. Indian Oil is the market leader, following which Castrol and HPCL run neck to neck. With various segments, within lubricant category such as automotive and industrial, we have tried to put ourselves in forefront in each of these segments. And here I'm only talking about value added lubricants because we also sell base oil as we have the largest lube base manufacturing refinery in Mumbai. If this product is also to be taken into account then our share in the lubricant category adds up to more than 35 percent.
Our marketing effort has borne fruits and contributed to HPCL' success story with lubricants. Going forward we will try to apply similar efforts and strategies to other product categories as well in order to further increase our market share.
Being an integrated marketing company and with no expertise in CGD (city gas distribution business), what are the opportunities that you see in bidding for CGD business?
For quite some time HPCL in partnership with GAIL has been doing pretty well in CGD business in places such as Andhra Pradesh and Madhya Pradesh. We also have some projects in Jalandhar.
Well, on gas per se, we have not been very active for a long time. We have CNG stations in Magadh. We are doing well in Gujarat where we have a very good coverage by CNG either on our own or as part of a joint venture (JV). It's a partnership which is taking off further. LPG is a very costly product to be used for cooking. Also, we must remember that 50 percent of LPG is imported. At half the quality value of LPG, the coal gas has been used from time immemorial. The issues with coal usage were environmental which are getting sorted out now.
There is no doubt that slowly and steadily LPG is getting replaced. But it's a very long-term process. We will keep our eyes open and accordingly go ahead with opportunities and projects suggesting a good yield. In fact, CGD is very much HPCL's forte because it is replacing our major product LPG.
What are the opportunities that you see in making investments in non- fuel retailing?
The country itself is not doing enough for non-fuel category. There are European countries where non-fuel business could be accounting for as much as 40 percent of retail earnings. Practically speaking, the non-fuel business at 50 hundred odd crore is nothing for us.
"The crude coming from Iran is a good quality crude and we are getting 90 days credit on it so the payment issue will be eventually worked out."
We are focusing on non-fuel business and making efforts to do whatever best we can to further push the business. We have tie-ups with major brands for eating and ATMs. One of our retail outlets in Sachgaon on Mumbai-Pune Expressway is the highest selling outlet in the country with a non-fuel income of about Rs 2 crore every year.
The best part of pursuing non-fuel business is that your topline and the bottomline is the same as there is no additional expenditure.
What is HPCL's short-term and long-term crude oil import strategy?
As is the case with the country, HPCL too imports about 80 to 85 percent of its total crude oil requirement. Again majority of our crude oil purchases in the range of 80 to 85 percent is by way of term crude oil for which contracts are signed at the beginning of the year. Another 10 to 15 percent of crude oil comes in the form of spot purchases. We buy from Iran and Saudi Arabia.
And in near future we do not see any significant change in our existing crude oil import strategy.
A sizeable quantity of HPCL's oil imports is from Middle East and particularly Iran. Given the recent payment crisis issue with Iran and the accompanying political upheaval in Middle East, what risk mitigation strategies does HPCL have in place to counter any fluctuation in supplies from Iran?
Not only HPCL but the entire country is heavily dependent on Middle East for oil. We are exploiting new locations as well. The potential sources for oil imports could be Latin America and Australia.
"In the next six years, HPCL is set to make huge investments with an eye to ramp up its production from 17 MMTPA to 42 MMTPA."
Iran is an extremely good supplier of crude oil for HPCL. Despite all the issues surrounding payment it continues to supply merrily. The crude coming from Iran is a good quality crude and we are getting 90 days credit on it so the payment issue will be eventually worked out.
More than HPCL, the payment crisis involving Iran should be more of a concern for a player like MRPL which is running fully on Iranian crude.
What are HPCL's plans for its domestic and overseas E&P assets?
We have a total of 25 blocks in India as well as abroad. Prize Petroleum which has been a JV company is being made into a 100 percent subsidiary. Subsequently, our entire E&P business will be carried out through it.
As far as investments in E&P business is concerned, we are looking for producing blocks and do not wish to make investments in excess of 15 to 20 percent in a particular block. This would help us spread the risk. Farming out could be another option and one could look at Australia and Africa.
What are HPCL's business plans for next five years?
In the next six years, HPCL is set to make huge investments with an eye to ramp up its production from 17 MMTPA to 42 MMTPA. Our expansion plans will see us investing Rs 45,000 crore over the next six years.
The HMEL-Bhatinda refinery is ready to be commissioned. We will be making huge investments at Vizag Refinery increasing our current capacity from nine MMTPA to 15 MMTPA. Our proposed grassroots refinery at Ratnagiri will also attract major share of this planned investment. Building and expansion of our pipeline network is another priority. We will also be spending substantial amount in expanding our retail network and further strengthening our marketing.
The government has asked integrated marketing companies to be more prudent in expanding their retail network. What is going to be the likely impact of this move on HPCL's expansion plans for its retail outlets?
First of all, I would like to state that the entry into rural areas for HPCL has been an original and old initiative. It was nearly four-five years back that we started what is called `Hamara Pump,' the branded, low-cost retail outlets in interior villages.
So, the focus on rural areas has been a priority with HPCL for a long-time and this focus would continue. There are areas where people have to nearly walk 10,000 km to get diesel. So, in order to cater to rural demand, HPCL is fully committed to reach out to such remote areas. Also, we must remember that rural agriculture has changed over the years. Today, people are increasingly using tractors and other agriculture equipment, which require diesel.
Moreover, all our retail outlets are set up based upon a return on investment (ROI). We are not setting up any retail outlet at less than the set ROI hurdle rate. As long as that is not violated, there is no issue in setting up a retail outlet. Essentially, the retail outlet that is being set up has to be viable. At present, we have more than 10,000 retail outlets. And we plan to roll out 500 to 600 retail outlets per annum over the next five years. And in doing so, our focus on rural markets will continue as HPCL has been a pioneer in this direction.
Branded fuel is struggling to find favour with consumers. Why has it failed to take off as a product category?
It is owing to the excise duty attracted by branded fuel that the effort in this category does not yield additional margin. There indeed are high-end vehicles which actually demand this branded fuel. Branded fuel is nothing but a choice given to the customers.
From our end there is no special focus on pushing branded fuel. It's being sold at modest rate which is fine with us.
(InfralineEnergy thanks B Mukherjee, Director (Finance), Hindustan Petroleum Corporation Limited (HPCL) 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 happening in the Indian energy sector.)