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$ 1.0
to 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.
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).


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.




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 quarter
ended 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.
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 353
per 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.
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 refinery
overcapacity and changing supply and demand patterns.
We expect refining margins to remain depressed outside of North America for some time to come, downstream
director John Abbott said at the firms management day.
Refining is suffering from overcapacity globally, because of declining demand in Europe and increasing capacity in
India, the Middle East and China. At the same time, the growth in US light tight oil, and in natural gas liquids globally
are increasing the yield of lighter products such as naphtha, LPG and gasoline. These changes in supply and
demand 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 profit
to $3.9bn.
The company is restructuring its refining and marketing business to try to improve profitability. The firm is mulling
further 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 of
capacity since 2008, or by 10pc, Abbott said. We have made a lot of progress, but there is clearly more to be done.









FURNACE OIL - 180 cst -PSU MT 42741.00 02 Apr 2014
FURNACE OIL 380 MT 42587.77 02 Apr 2014
LIGHT DIESEL OIL PSU (Basic) KL 53115.00 02 Apr 2014
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 2014
LABFS MT 52156.70 02 Apr 2014
SBP 55/115 KL 62600.00 02 Apr 2014
HEXANE KL 56400.00 02 Apr 2014
MTO (LAWS) KL 59550.00 02 Apr 2014
BENZENE MT 79300.00 02 Apr 2014
TOLUENE MT 67500.00 02 Apr 2014
SUPERIOR KEROSENE OIL (IND) KL 51486.00 02 Apr 2014
BITUMEN BULK 80/100 MT 41591.00 02 Apr 2014
BITUMEN PACKED 80/100 MT 44691.00 02 Apr 2014
BITUMEN BULK 60/70 MT 42391.00 02 Apr 2014
BITUMEN PACKED 60/70 MT 45491.00 02 Apr 2014
BITUMEN BULK - 30/40 MT 45441.00 02 Apr 2014
BITUMEN PACKED 30/40 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