The need for working capital in the oil refining business emanates from inventory holding across the value chain including:
Where an oil refiner is able to process crude and sell products within the credit period offered by suppliers, maintaining a negative working capital cycle from refining operations becomes feasible.
- Crude inventory
- Petroleum product inventory
Sustaining a negative working capital cycle from the refining business is dependent on the credit period provided by crude creditors and trans-shipment period of crude. Where an oil refiner is able to process crude and sell products within the credit period offered by suppliers, maintaining a negative working capital cycle from refining operations becomes feasible.
Where refining operations are not completed within the credit period offered by crude suppliers, availing foreign currency denominated working capital financing can help maintain the negative working capital cycle. On an overall basis, refining operations should strive to maintain the outstanding value of crude creditors and foreign currency denominated working capital facilities at a value equal to inventory carrying cost.
Maintaining the outstanding value of crude creditors and foreign currency denominated working capital financing at levels equal to the cost of inventory, apart from funding inventory, also synthetically hedges the carrying value of inventory. While inventory is at lower of cost of fair market value for the purpose of accounting, the fair value of inventory is equal to the price of crude or products multiplied by the prevailing US$-INR rate.
Where the outstanding value of foreign currency denominated crude creditors and foreign currency denominated working capital financing equates with the value of inventory outstanding, currency risk is synthetically hedged. However, it may be noted, that average pricing periods for domestic sales of products lead to a part of the physical inventory being carried by the refiner actually getting priced out before effecting transfer from the refinery.
Efficient management of working capital from marketing operations is dependent on the following aspects:
- Efficiency in up streaming cash from depots, petrol pumps and traders
- Managing deficit financing until oil bonds are allotted to make up for under-recoveries
- Decisions of liquidating oil bonds to finance working capital
Over the years, improvement in cash management services offered by banks as well as efforts by refiners to improve visibility over cash by leveraging electronic banking facilities has led to improved up streaming of cash. However, under-recoveries and delays in allotting oil bonds have continued to put pressure on the working capital requirements for the marketing business.
Refiners have also continued to hold oil bonds without a clear disposition strategy.
As on 31 March 2010, the total holding of oil bonds of three leading oil refiners totaled US$7.65 billion. Positive working capital cycle from marketing operations may be effectively managed through increased foreign currency denominated working capital financing pertaining to crude imports.
This may be achieved by increasing the tenor of buyer’s credit for crude imports. A clear strategy on disposition of oil bonds based on assessment of available surpluses, post-tax return and prevailing yields is important to manage return on equity.
*Refer to the attached PDF for source information