Inflation is sky-rocketting these days and one of the major factors impacting the rising inflation includes the rise in prices of oil related commondities. When reading articles about the oil & gas industry in newspapers and magazines there's industry specific jargon that one may not be aware with. To acquaint with the same, this article looks at some of the commonly used terms. While reading, you would also understand how oil industry actually works..
Firstly we shall bifurcate the oil and gas industry according to the nature of work done-it can be divided into mainly two categories-upstream and downstream sectors. The upstream sector includes companies engaged in exploration and production of oil & gas. The downstream sector is into the refining as well as the selling & distribution of oil & gas products. So all the products made from oil refining-including LPG, gasoline & diesel oil are produced by the downstream sector. Oil Marketing Companies (OMC) are part of the downstream sector. Popular OMC's in India include Indian Oil, HPCL, BPCL etc. Upstream companies in India include-Oil India, ONGC & GAIL.
Although the prices of petrol have been deregularized and there is much hue & cry amongst the price-sensitive aam aadmi, the fact remains that diesel & LPG is adminstered at prices lower than the international prices. OMC's suffer heavy losses due to difference
between the selling price(i.e. the price at which is sold finally to the Indian consumers) and the market price (the price at which it is sold internationally). This is called under-recoveries. The burden of under-recoveries is borne by the government (which provides cash compensation to OMC's), Upstream Co.'s (in the form of price discounts to OMC's) & finally by the OMC's themselves. The large chunk, however is borne by the government which is almost equal to 70%. One may think that the losses of OMC's should subside due to deregualtion of petrol last year. However, the irony here is that petrol constitutes only a tiny portion of the fiscal burden that the government has to bear due to under-recoveries. Diesel and LPG consitute the large chunk.Recently oil touched the $100 per barrel mark (& rising...) due to the political turmoil in Egypt and the middle east, this would definetely hit the balance sheets and financial reports of OMC's bad.
Although OMC's suffer heavy losses due to under-recoveries, the concept of losses and under-recoveries should not be used interchangably. Under-recoveries occur due to difference in the market price and the selling price of oil products whereas losses occur if cost exceeds the selling price.
If we carefuly look at the quarterly and the annual financial statements of OMC's, we would find there is great variablity in the profitability position amongst consecutive time intervals. This is due to the fact government compensation to the OMC's for under-recoveries is often delayed. Due to this OMC's profits yo-yo widly according to when they receive the compensation from the government. When there is delay in compensation, OMC's infuse huge amounts of cash to keep the show going.
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A quick trivia: After the collapse of Bretten Woods, one of the key reasons why the US Dollar bounced back was because oil per barrel was denominated in terms of USD. Sufficient oil reserves & a resurgent demand of US currency helped the US Dollar get back on track..!
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By:Tejas Singh
