A clutch of international oil majors is reportedly seeking equity stakes in upcoming refinery projects in India. Oil refineries are large, capital-intensive projects, and the foreign direct investment on offer ought clearly to be welcomed.
But while we okay the project proposals in a giffy, we surely need to promptly do away with the extant high effective tariff protection for oil refining. Otherwise, the high effective tariff walls for refined petroleum products would simply imply tariff jumping on the part of global oil majors seeking high unearned rents!
News reports say Saudi Aramco is in talks to pick up stake in Indian Oil’s Paradip refinery. Aramco is also seeking equity in HPCL’s Vizag refinery, as indeed is Total of France. Further, in oil refineries across the land, in Mangalore, Bina, Bhathinda and elsewhere, international majors seem keen to acquire a substantial piece of the investment cake. In fact, the high effective tariffs on oil products is perverse incentive to do so.
After all, the duty regime jacks up gross refinery margins across the board and hikes costs in the oil economy and beyond. In terms of policy initiatives, what is required is that we do away summarily with the duty differential between crude and products. Otherwise, we would be saddled with wholly high-cost oil assets.
A word about refinery economics. The fact is that the value-added in oil refining is quite minimal, of no more than 10%. So even a nominal duty differential between crude and products implies huge tariff protection for the value-added. This is quite unlike most other industries, where there is generally considerable value-addition downstream. Yet for long years, we have had a policy of high effective tariff protection for oil products purportedly to boost refinery projects. This has meant high duty differential between crude and refined products, and effective tariffs on products that have generally been over 50%! And even in recent years, we have opted to have such a high-cost duty structure even as tariffs generally have been reduced.
The recent expert committee on pricing and taxation of petroleum products, headed by Dr C Rangarajan, estimated the tariff protection for oil products at 40%.
Given the panoply of policy distortions in our oil sector, such as the effective ring-fencing of retail sales, the actual tariff levels would almost certainly have been much higher. In a voluminous industry like oil, such high tariffs are a glaring anomaly and guaranteed to give rise to needlessly high-cost refinery output.
Thankfully, of late, the duties on petro-products have been pruned. While the import duty on crude is pegged at 5%, that for products like diesel and petrol have been reduced, slightly, to 7.5%, from 10%.
But despite the reduction in the duty differential last year, effective tariff protection for products remains upwards of 20% given the lowly value-addition in oil refining. The point is, compared to the prevailing tariff rates in the rest of the economy, the effective duty levels for petro-goods remains much too high.
What is urgently required is that we remove the duty differential between crude and products once and for all. The logistics and sheer scale economies in shipping oil ought to be protection enough. A zero duty differential between crude and products would bring down untoward rents and stem gross refinery margins as well. And it would remove the perverse incentive to buy into Indian refinery assets to rake in rents propped up by policy fiat.
In a high-growth economy, oil refineries would be perfectly viable without policy prop-ups and sundry other sweeteners. Indian refiners can eminently do without high tariff protection on products. Instead, the watchword needs to be efficiency and sustained process innovation.
Beyond ungainly high tariffs, the overall economic viability and efficiency of an oil refinery depends on the interaction of three key factors: the choice of crude oil used, the complexity of refining installations—refinery configuration—and the desired type and quality of products refined. Additionally, refinery utilisation rates and environmental considerations also do affect refinery economics.
For example, using more expensive crude oil (‘sweeter’, lighter) requires less refinery upgrading but supplies of light, sweet crude are at a premium and the differential in prices between lighter and more heavier crudes is seen to be increasing. Using cheaper heavier crude oil means more investment in refinery processes, sure.
But the overall returns and payback can be substantially attractive with the right sourcing of crude and with proper refinery configuration. Additionally, the quality specifications of the final products are also increasingly important as environmental requirements become more stringent.
INDIA TIMES
