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OIL MARKETING COMPETITION HEATS UP

Efforts being made to retain market share by offering better services

By SHABBIR H. KAZMI
Mar 26 - Apr 01

The government of Pakistan (GoP) aims at minimizing state controls and eliminating subsidies given to local industries. The recent deregulation of Petroleum, Oil and Lubricant (POL) products trade, is also part of its two tier policy: attracting investment in oil and gas sector and accelerating the pace of privatization. While the shift in the GoP policy will open up the oil marketing sector to new investment, the move is expected to intensify the competition among the three oil marketing companies (OMCs). Deregulation of furnace oil business has rationalized its price in the local market. While the deregulation of motor gasoline and diesel trade is expected to put pressure on the profitability of OMCs, the policy is expected to have positive impact on the economic revival efforts of the present government.

The oil marketing sector mainly consist of three companies namely Pakistan State Oil Company, Shell Pakistan and Caltex Pakistan. PSO enjoys the largest market share followed by Shell and Caltex. In the changed market scenario profitability of these companies will be directly related to volume of sales. Therefore, all the companies are investing heavily to improve the quality of services being offered at their outlets.

Business climate

POL products provide around 43 per cent of Pakistan's total energy requirements, the rest being met by natural gas and electricity. During 1999-2000 the demand for POL products increased to 17.6 million tonnes representing 6.3 per cent growth over the previous year. The consumption included 6.2 million tonnes of furnace oil and 5.5 million tonnes of high speed diesel (HSD) and the balance consisted of other products. While motor gasoline demand declined by 5.6 per cent due to substitution by CNG, HSD demand was up by over 5 per cent and furnace oil demand increased by nearly 10 per cent due to increased consumption by IPPs, WAPDA and KESC.

Untill recently local refineries were meeting only 33 per cent of the domestic requirements and the remaining 67 per cent demand was met through import. However, with the commencement of Pak Arab Refinery, having a refining capacity of 4.5 million tonnes per annum, the country has become surplus in certain products.

The GoP has initiated measures to completely deregulate the POL trade in phases. Initially furnace oil imports were deregulated with lifting of price controls. Motor gasoline and diesel trade is being liberalized. Sales volume of furnace oil is expected to decline due to the GoP's policy to encourage use of gas by the electricity producers. The high-margin lubricants business encouraged other international companies to enter Pakistan. Over the last 12 months, companies like Elf-Total, BP-Amoco and several smaller regional companies have entered the Pakistan market.

Crude oil prices

As the worst of winter is nearing its end and reports also indicate above average inventories, prices of crude oil are expected to decline but remain with a certain bandwidth. OPEC has expressed repeatedly that it would not allow crude oil prices to plunge beyound certain level. Crude oil prices are managed through cuts in daily production quota. The GoP has also decided to revise POL prices on quarterly basis. After a long time, prices of POL products were reduced this month. As the international prices of crude are expected to go down further, consumers may expect further reduction. However, the reduction will be largely depend on rupee dollar parity.

Pol transportation

Till recently, bulk of the POL movement to up country was from Karachi be it locally refined or imported products. PARCO's pipeline used to handle most of the quantity and remaining was sent through railway wagons and tank lorries. After the commencement of PARCO, this pipeline has been dedicated for transportation of crude oil. However, a new white oil pipeline is scheduled to come on line in 2002. As the GoP has started deregulation of POL trade, now transportation cost will play a key role in determining the profitability of the OMCs.

Privatization of pso

The GoP has accelerated its efforts to privatize state-owned enterprises including PSO. It is often said that the size of the Company its paid-up capital and volume of business was a hurdle in its privatization. However, some sector analysts say that the senior management has been the biggest opponent of PSO's privatization. They also say that profit of the Company would have been much higher had it not suffering from extravaganza and some financial irregularities. A new managing director, from the private sector, has been appointed recently. Under his able leadership efforts are being made to restructure the Company and also exercise cost controls.

The current economic managers have indicated, on more than one occasions, that they plan to off-load the GoP shareholding in various state enterprises through stock exchanges. PSO can be a good test case. It is already listed at stock exchanges, dividend payouts are very high, daily trading volumes are large and the scrip is quoted much above par value. Therefore, sale of atleast 10 per cent shares would be appropriate looking at the market appetite.

POL prices

The POL consumption is considered to have an inelastic demand. The consumption volume of furnace oil and HSD have been increasing despite increase in their prices. However, in last couple of years demand for motor gasoline has witnessed declining trend in its consumption. The lower offtake is due to gradual shift to other fuels, CNG in particular.

Historically, the GoP has been collecting a very substantial amount as development surcharge on POL products to compensate for lower CBR-related revenue collection. While the international lenders did not appreciate this policy, the resistance against this practice also developed to a large extend locally. During the present military regime efforts are being made to minimize dependence on this surcharge. Therefore, it was decided to review POL prices on quarterly basis. The GoP has announced reduction in POL products prices this month.

OMCs are already under pressure due to the gradual deregulation of the POL trade. The latest reduction in prices is expected to put further pressure on the earnings of OMCs. With the reduction in POL prices, companies will face inventory losses. In the past, they were making substantial profit due to inventory gains. However, the extent of inventory losses, in the near future, would largely dependent on the inventory management policy of each company.

PSO may face the most adverse situation due to its higher inventory levels. The Company has not been used to this type of situation in the past. It is also apprehended that the Company does not have a very efficient inventory management system. Shell has been very active on this front and has invested substantial amount in acquiring state-of-the-art inventory management system. This system is expected to give Shell an edge over its other competitors.

In theory, one should expect an increase in motor gasoline offtake after the reduction in its prices. In reality the increase can only be marginal keeping in view the gradual switchover to CNG and HSD. The reduction in HSD price, by almost 17 per cent, may encourage its more use. The reduction in transportation cost will have a positive impact on the overall profitability of fertilizer and cement companies in particular. As a result of improvement in corporate earnings the country may witness increase in BMR as well as fresh investment.

Dealer margin

The GoP has decided to increase the dealer's margin on POL products by one per cent from April 1, this year. However, the key issue is the ultimate dismantling of freight pool system, whereby all retail outlets across the country have exactly the same prices for the products. According to a report by KASB, "As deregulation proceeds, this method becomes onerous for the government finances. Thus, we believe that this increase in margin is but the first step in gradually ending the freight pool system over time. While the cost to exchequer is reportedly going to be Rs 1.5 billion because of this one per cent increase in dealers commission, the government hopes to offset this by reduced charges on transportation at secondary distribution level which would now be borne by the oil marketing companies."

The report further says, "The immediate impact on the end consumers is initially likely to be neutral while in the near term the OMCs might face marginally higher distribution costs. If this view is correct, then we feel that over the medium term there may be a potential for distribution margins also being enhanced. That is where OMCs would certainly benefit from a bottom line perspective. However, it is too early to give a considered view untill some clear indication in this regard is forthcoming from the government."

The players

Pakistan State Oil Company (PSO) is the largest OMC and the only national company in the business of POL products marketing business. During the year 1999-2000 the Company sold a total volume of 12.7 million tonnes as against 12.1 million in the previous year. The total sales increased by 17 per cent amounting to Rs 135 billion. The Company has undertaken a number of steps to arrest the decline in its market share over the last several years. It has launched a plan to build New Vision outlets to provide better quality service to its customers.

At present PSO has more than 3800 outlets located throughout the country. Out of these, 150 outlets have been revamped so far and another 40 will be fully functional by the year end. At the same time the number of company owned and operated outlets has been increasing. To motivate and strengthen dealer network 'Million Litre Award' has been initiated. During 1999-2000 efforts of 11 dealers were recognized through distribution of this award.

After the deregulation of furnace oil business in July 2000, PSO was the first OMC to invite international bids for import of the product. A total of 1.9 million tonnes furnace oil was imported by the Company during July-October period. The Company maintained uninterrupted supplies insipite of huge demand by WAPDA, due to lower hydel power generation and explosion at Kuwait Petroleum Company refinery. PSO has signed a long-term product off-take agreement with PARCO. The Board of Directors has approved the acquisition of 12 per cent (approximately Rs 950 million) in Karachi-Mehmood Kot 864 kilometer long white oil pipeline project, which is scheduled to be completed by December 2002.

SALES VOLUME

(Million tonnes)

Year

Quantity

1996

11.6

1997

11.9

1998

12.7

1999

12.1

2000

12.7

REVENUES

(Rs in billions)

Year

Quantity

.

81

1997

110

1998

121

1999

116

2000

135

Shell Pakistan is not only the second largest company, enjoying 32% of the market share, but it also offers superior quality services to its customers. To further improve its services, it has been developing a network of Company-operated sites. Whilst contributing to the bottom line, these serves as models of excellence for dealer-operated outlets and are also used for testing market initiatives. Another customer service, the 'Shell Genie' fast and free oil change facility has been extended to more outlets. This has helped the company in increasing its lubricants sale. A site in Rawalpindi has set a new world record by carrying out 1,678 oil changes in a single day. Its Lube Oil Blending plant is ISO-9000 certified ensuring continued supply of highest quality products. The Company has also initiated agency business for a new range of gear oils for commercial transport customers.

Shell has also initiated Business Process Re-engineering project  CHIPS. This project is planned for completion within this year. This name reflects the key themes: Change, Integrate and Profit. The Company envisages to achieve revolutionary change in the way people work; by harnessing new technology to streamline business processes and focus on customers. The Company plans to link over 30 locations via a new satellite-based telecommunication network providing up-to-date information on details such as customer orders, delivery status and stock levels. Another milestone in IT infrastructure include the connectivity of Shell House to all its major outlets in Karachi over a fully backed up 'Line of Sight Radio' communication network. The network is constructed in such a way that communication to Shell House can never be disrupted. An advance Remote Access System has been installed to provide 24 hour on-line access to Shell House. This has allowed access to the Head Office network by all remote users.

In 1993 The Royal Dutch Shell Group acquired a controlling interest in Shell Pakistan and, since then, profits have improved substantially. Profits are not only used to pay dividend and taxes, the amounts are also reinvested. Over the last seven years more than Rs 5 billion have been spent on building new and improving existing assets. Out of this the most visible investments are in branded service stations and tank lorries. Upto June 30, 2000, the total number of such outlets was 386.

SALES VOLUME

(Million tonnes)

Year

Quantity

1996

3.0

1997

2.9

1998

3.2

1999

3.5

2000

3.7

REVENUE

(Rs in billions)

Year

Amount

1996

27

1997

38

1998

43

1999

50

2000

62

Caltex Pakistan has a smaller market share as compared to other two giants. To combat the onslaught of the process of deregulation, the Company has formed an alliance with Shell for import and handling of gasoline and HSD. However, the Company is not expected to witness any substantial gain in its market share due to a constrain of limited number of outlets.

Attock Oil Refinery acquired the permission to establish its own outlets some years ago. It had the plan to establish these outlets in the northern region. It is expected that after the increase in its refining capacity the Company would start establishing its own outlets.

Pak Arab Refinery has formed strategic alliance with some of the world leaders for marketing of its products. Since it has a very large refining capacity and some of the products being produced are in surplus, it has two options: export the surplus or establish its own outlets. Raising money to establish the outlets should not be a problem. However, sector analysts believe, that its top priority is establishing the white oil pipeline which is scheduled to come on line in 2002.

Outlook

The GoP must undertake speedy privatization of PSO. In the mean time at least 10 per cent of the shares owned by the GoP should be off-loaded through stock exchanges. Sale of PSO shares will not only enable the GoP to raise substantial money but will also help in convincing investors that it is serious in privatizing state enterprises. There seems to be no hurdle except lack of will on the part of the GoP.

The OMCs will experience a decline in their margins. Sales volume will play a key role in the profitability of the companies. The companies already face a severe competition. In future, two factors will determine the profitability of the OMCs. These are: volume being handled and inventory management system. Prudent inventory management system is will play a key role as further reduction in POL prices is expected.

The reduction in POL prices will have a positive impact on the economy in general and fertilizer and cement sector in particular. Most of the domestic industries will experience a relatively more favourable cost base. This alongwith expectations of improving economic growth may improve the overall corporate earnings.