Refining Grm

7/22/2019 Refining Grm

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REFINING : UNDERSTANDING OF GRM

After touching historic lows in the late 1990s, the oil-refining sector has seen a significant increase in

gross refining margins (GRMs) owing to two factors. One, hardening of crude prices and secondly, a

favorable demand- supply equation in the global markets. As compared to GRMs in the range of US$ 1.0to US$ 1.5 per barrel in late 1990s, GRMs crossed US$ 10 per barrel at one stage. Though margins have

softened in the recent past, it is still substantially higher than the average of the last three years.

Now, what is GRM? Simply put, GRMs are like the gross profit (and not EBDITA) for a steel company and

it is always calculated per barrel (say, gross profit per MT for a steel company). Gross profit calculation

excludes employee and administrative expenses. In this article, we analyse the composition of GRMs,

how they are calculated, and how various regulatory policies in the form of protection affects the GRMs.

How are GRMs calculated?

Crude oil is the primary input cost for a refinery (90% to 95% of the total cost of refining). Refineries

processes the crude oil purchased into various value-added products, which in turn are classified as light,

middle and heavy distillates. A refinery tries to optimize its capacity to produce more remunerative

distillates to boost margins (petrol and diesel).

GRMs (in US$ per barrel) can be defined as the difference between the costs of raw material (majorly

crude) and weighted average prices of petroleum products. Given the fact that GRMs of the refining

business depends on the weighted average prices of petroleum products, we need to understand the

pricing mechanism of the petroleum products followed by the Indian refineries. Before deregulation,

refining margins were 'administered' by the government on the basis of fixed return on capital employed

(i.e. cost plus basis). However, following the dismantling of the administered pricing mechanism (APM),

the refinery-gate-transfer-price (RGTP) of petroleum products was fixed on the basis of import-parity

principle.

To simplify, here is a hypothetical example. Assume that a refinery processed 1 barrel of crude and

derives output in the form of 28 gallon of diesel and 14 gallons of other products (say petrol and heating

oil).Assuming the crude prices are US$ 65 and price of diesel (Refinery gate prices) are US$ 2.0/gallon,

while the weighted average prices of other products are US$ 1.4/gallon.

Then the GRMs are = (28* 2.0 + 1.4*14) - 65

This translates into a GRM of US$ 10.6 per barrel.


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How petroleum products are priced?

There are various ways to price petroleum products:

Import parity pricing Export parity pricing

Trade parity pricing

Import parity pricing is based on the principal of opportunity cost, as this pricing mechanism the mark-up

of freight, insurance, ocean losses, port dues and custom duties, to the benchmark (Singapore margins).

However, given the fact that country has surplus refining capacity, the pricing mechanism seems to be

flawed. Recently, the government shifted from import-parity to trade-parity pricing, which is a blend of

import-parity and export parity pricing (currently 80:20). Thus, import parity pricing leads to higher

revenues and profits for the refineries, due to the protection enjoyed by the domestic refineries in the form

of custom duties.

Given fact that every refinery can be unique (in terms of its ability to produce products and process

various crude forms), the production levels can be different. Thus determination of benchmark GRMs

using the weighted average production of various refineries becomes a difficult task. The benchmark

Singapore margins calculation assumes a product mix of approximately 32% of gasoline (petrol), 19% of

jet fuel and kerosene, 16% of diesel/gasoil, 23% of fuel oil, 3% LPG and 7% MTBE/naphtha, and Dubai

crude oil as input. The prices of various products are determined on the basis of demand-supply. Thus, a

refinery, which can produce more high-value products or refine various forms of crude, can post GRMs

above the benchmark GRMs.

Composition of GRMs:

GRMs can be further divided into two parts:

Core GRMs

GRMs due to tariff protection

Core GRMs are the GRMs, which a refiner would have earned in the absence of any custom duties.

GRMs due to tariff protection are the incremental profits earned due to higher domestic refinery-gate-

prices (due to inclusion of custom duties in prices).


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For Example :

Calculation of GRMs due to protection effect

Particulars Assumes prices in US $

Crude prices 40 50 60 70 80

Custom duty of crude 5% 5% 5% 5% 5%Effective crude prices 42.0 52.5 63.0 73.5 84.0

Product prices 47 57 67 77 87

Custom duty on products 7.5% 7.5% 7.5% 7.5% 7.5%

Effective product prices 50.5 61.3 72.0 82.8 93.5

GRMs ( without protection) 7.0 7.0 7.0 7.0 7.0

GRMs ( with protection) 8.5 8.8 9.0 9.3 9.5

GRMs due to tariff protection 1.5 1.8 2.0 2.3 2.5

In the Indian scenario, recently, the government reduced the custom duty on petrol and diesel from 10%

to 7.5% thereby reducing the protection available to the domestic refineries. Broadly speaking, if the

custom duty on crude is lower than the custom duty on products, then the protection effect is positive.

The effect of entry tax on crude:Some states in India levy entry tax on crude (for example, in

Maharashtra, it is at the rate of 3%). Entry tax on crude eats into refining margins and reduces the

effective protection available to the refineries. Since both HPCL and BPCL have refineries in Mumbai,

they enjoy lower margins as compared to that of IOC.

Effect of entry tax on the GRMs

Particulars Assumes prices in US $

Crude prices 40 50 60 70 80

Entry tax 3% 3% 3% 3% 3%Effective crude prices 41.2 51.5 61.8 72.1 82.4

Product prices 47 57 67 77 87

GRMs post- tax adjustment 5.8 5.5 5.2 4.9 4.6

GRMs pre-tax adjustment 7.0 7.0 7.0 7.0 7.0

Loss on a/c of entry tax 1.2 1.5 1.8 2.1 2.4

To conclude, it is pertinent to understand that if refining margins are higher in the global markets, it does

not necessarily translate into higher profits for Indian refiners.The level of customs duty and state-level

duties (not only on crude prices but also on end-product prices) does impact margins. Also, while

investing in a refining company, it is always advisable to base one's investment decision on 'normalised'

GRMs (long-term averages) as opposed to temporary blips.


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What is the gross refining margin?

Suppose a refinery buys one barrel of crude oil at $100. It breaks this down to various quantities of

petrol, diesel, aviation turbine fuel, naphtha, kerosene, furnace oil etc. Suppose these products, as a

basket, are sold at $105. In this case, the gross refining margin is said to be $5 per barrel. The

refining margin is thus the difference between the total value of petroleum products produced by the

oil refinery and the price of the input i.e. crude oil.

Higer the GRM's higher the Profit Yields.

The factors that have contributed to high GRMs are

1)Cost of sourcing crude oil

2Manufacturing reliability and efficiency

3)Ability to produce quality transportation fuels

4)Flexibility of crude oil receipt and product evacuation infrastructure

Gross refining margin improves: The gross refining margin (GRM) of almost all the refinery

companies improved in the quarter and the year ended March 2008 compared with

corresponding previous-year periods. RILs GRM was US$ 15.5 per barrel in the quarterended March 2008. Indian Oils GRM improved to US$ 9.02 per barrel in FY 2008 as against

US$ 4.19 per bbl in FY 2007. HPCLs GRM was US$ 5.98 per bbl (FY 2007: US$ 4.78 per bbl)

for the Mumbai refinery and US$ 6.98 per bbl (FY 2007: US$ 3.51 per bbl) for the Visakh

refinery in FY 2008. Chennai Petroleums GRM stood at $9.59 per barrel in the quarter ended

March 2008 as against US$ 6.421/per barrel in the March 2007 quarter.

And RPL is expected to have a high GRM of $17/Barrel which is nearly $1.5/barrel in premium when

compared to Reliance GRM.

Reliance GRM Trend View

How do customs duties on petro products determine gross refining margins?

For petro products manufactured by them, oil refineries in India are paid the import parity price,

the international price plus the insurance and freight cost plus the customs duty. Thus, higher the

customs duty, higher will be the gross refining margin.


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What would happen if customs duty on petro products is reduced?

If the customs duty is cut, say, to 10 per cent, the domestic company would reduce its price from 15

per cent above the landed cost to 10 per cent above the import parity price. In case it does not do so,

the customer, that is the marketing company, will import the product. India does not import petrol,

but a cut in customs duty on petrol reduces the domestic price of petrol.

What can the Government do if world oil prices keep rising?

The first step should be to eliminate rate dispersion by bringing down the duties on petro products.

When the customs duty on crude oil and petroleum products is equal, then this anomalous

profitability of Indian refineries would be removed.

But once customs duties are brought to zero, how can the Indian consumer be

protected from the rise in world oil prices?

While all agree that low inflation is a desirable objective, it is not desirable to achieve low inflation by

artificially keeping the price of oil products low. As world oil prices rise, and show no particular signs

of going back to the old levels, the economy needs to adjust itself to higher prices. If not, the

Government will not only end up bearing the subsidy bill, whether itself or impose it on oil

companies, but also in encouraging the consumption of oil in a world where its price is much higher.

Under-recoveries in OMC's

Un-derrecoveries are mounting for Indian public sector oil marketing companies (OMCs) due to the

spike in global crude oil prices. This has lead to net losses in the March 2008 quarter by Indian Oil.

Hindustan Petroleum Corporations (HPCL) net profit due to tax writeback was Rs 408.61 crore.

Petrol, diesel, public distribution system kerosene and domestic LPG are sold at prices lower than

the estimated cost of production (inclusive of refinery margin). This leads to un-derrecoveries for

OMCs, projected around Rs 245305 crore in the year ended March 2009 (FY 2009). In view of the

surging un-derrecoveries, the Union government increased the price of petrol by Rs 5 per liter

against the required increase of Rs 21.43 per liter, diesel by Rs 3 per liter against the required

increase of Rs 31.58 per liter and LPG by Rs 50 per cylinder against the required increase of Rs 353per cylinder. There was no increase in the prices of kerosene.

The Union government also reduced custom duty on crude to nil from 5% to 2.5% from 7.5% on

petrol and diesel, and from 10% to 5% on other petroleum products. The excise duty on petrol and

diesel was also reduced by Re 1 per litre.


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As a result, a significant portion of the estimated underrecoveries of Rs 245305 crore will be financed

as follows: Rs 22660 crore through duty changes, Rs 21123 crore from price revision, Rs 40000 crore

sharing from upstream companies, oil bonds at around Rs 135000 crore, and the balance to be

absorbed by PSU OMCs.

The current fiscal will be eventful with Reliance Petroleum set to commence commercial production,

while the groundwork for the stalled Nagarjuna Petroleum slated to start shortly. With a slew of

other projects set to come on steam in due course, India is positioning itself as a refining hub for the

global markets.

MARCH 2014- Shell expects refining margins outside North America to remain under pressure as a result of refineryovercapacity and changing supply and demand patterns.

We expect refining margins to remain depressed outside of North America for some time to come, downstreamdirector John Abbott said at the firms management day.

Refining is suffering from overcapacity globally, because of declining demand in Europe and increasing capacity inIndia, the Middle East and China. At the same time, the growth in US light tight oil, and in natural gas liquids globallyare increasing the yield of lighter products such as naphtha, LPG and gasoline. These changes in supply anddemand patterns are reshaping crude and product trade flows and causing price distortions, he said.

Shells refining margins fell significantly last year, contributing to a 28pc year-on-year decline in its downstream profitto $3.9bn.

The company is restructuring its refining and marketing business to try to improve profitability. The firm is mullingfurther divestments after recently agreeing to sell the bulk of its downstream operations in Australia and Italy.

We have reduced the refinery portfolio by 1.4mn b/d since 2002, which is a 30pc reduction, and by 400,000 b/d ofcapacity since 2008, or by 10pc, Abbott said. We have made a lot of progress, but there is clearly more to be done.


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FURNACE OIL - 180 cst -PSU MT 42741.00 02 Apr 2014

FURNACE OIL 380 MT 42587.77 02 Apr 201

LIGHT DIESEL OILPSU (Basic) KL 53115.00 02 Apr 201

LSHS MT 44491.00 02 Apr 2014

NAPHTHA FOR GENERAL USE MT 63671.00 02 Apr 2014

SCN (REF.NAP) MT 63921.00 02 Apr 201

LABFS MT 52156.70 02 Apr 2014

SBP 55/115 KL 62600.00 02 Apr 2014

HEXANE KL 56400.00 02 Apr 201

MTO (LAWS) KL 59550.00 02 Apr 201

BENZENE MT 79300.00 02 Apr 201


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TOLUENE MT 67500.00 02 Apr 201

SUPERIOR KEROSENE OIL (IND) KL 51486.00 02 Apr 201

BITUMEN BULK80/100 MT 41591.00 02 Apr 2014

BITUMEN PACKED

80/100 MT 44691.00 02 Apr 2014

BITUMEN BULK60/70 MT 42391.00 02 Apr 2014

BITUMEN PACKED60/70 MT 45491.00 02 Apr 2014

BITUMEN BULK - 30/40 MT 45441.00 02 Apr 201

BITUMEN PACKED30/40 MT 48541.00 02 Apr 2014

HSD FDZ KL 56519.78 02 Apr 2014

MS (FDZ) KL 61785.23 02 Apr 2014

Source : Various reports, Internet Resource

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