Analysis. An era of transformation for public sector OMCs

Public sector oil marketing companies (OMCs) have been undergoing a significant transformation over the last few years, after deregulation. In the first phase, deregulation helped them deleverage their balance sheets. In the second phase, declining crude oil prices led to improved refining margins, reduced working capital and enhanced cash flows.

OMCs used these phases of opportunities to transform their business into a completely new avatar which is more agile, profitable and durable. Rising operating cash flows enabled these companies to invest in upgrading their refineries and also fortify the economic moat in the fuel marketing business. Focused efforts in these areas enabled OMCs to significantly compound the benefits of deregulation and declining oil prices, thereby creating value for all stakeholders.

All the three OMCs have extensively transformed their refineries by investing $20-25 billion over the last five years.

These investments have been directed towards increasing refinery complexity level, enhancing flexibility in configuration, improved fuel consumption, dynamic crude sourcing, maximising value added products (like lubes), and adoption of indigenously developed technologies.

This is clearly reflected in the 300-400bps improvement in their distillate yield and constrained operating cost escalation over the last 5-7 years. In my view, these initiatives have led to a sustainable increase of 40-60 cents in their refining margins.

Going forward, OMCs’ core refining margins could sustainably trade at a premium to benchmark Singapore margins as compared to a sharp discount earlier.

The newly built refineries have best-in-class technologies, including some secondary units running on indigenously developed technologies.

Post deregulation, OMCs have been investing heavily in expanding the economic moat in their fuel marketing business. They have demonstrated strong focus on quality, reach and technology to defend their moat in fuel marketing and limit market share loss to private sector.

Retail marketing infrastructure has been ramped up by almost 50 per cent over the last five years, which includes widescale increase in retail outlets, expansion of pipeline network, terminals and LPG distribution.

Adrian Slywotzky, author of the book Value Migration , defines value migration as a flow of economic value from outmoded, obsolete businesses towards those with superior business designs. The latter ones are better positioned to create utility and comfort for customers.

Fuel marketing business in India is witnessing the same phenomenon, especially with opening up of the market to private sector and issuance of new licences to multinational fuel marketing companies. Business models existing for many decades would become obsolete if not transformed to eliminate the gap between customer priorities and existing business designs. Customer preferences have changed materially over the ages with digitisation, better information access and changing lifestyles.

Today, customers demand quality assurance, competitive price, quick fill, digitised services, loyalty benefits, vehicle and consumer care services, non-fuel retail services, etc, at the outlet.

Going forward, a fuel marketer cannot survive just as a commodity seller. Fuel marketers have to transform their business into a service provider. While OMCs cannot restrict private sector players from gaining some base market share, they seem to be well equipped to limit the loss.

It is encouraging to see OMCs taking multiple steps with a strong vigour to protect their economic moat amidst this value migration. We can clearly see their strong focus on customer loyalty, market leadership and dealer loyalty.

All the three OMCs have been vigorously introducing initiatives in loyalty programs, assured quality and quantity checks, assured quick fills, fleet management end-to-end services, mobile and online access to information like price, services, etc, and at every outlet, app-based digital services, journey planner, multi retail outlet for truckers, market place offering at rural outlets, etc.

While these initiatives have kicked off at select outlets, the progress seems to be encouraging. Also, 40 per cent of the OMC retail outlets are already automated and this is likely to reach 100 per cent over the next 15-20 months.

An automated outlet provides transparency and control of all facets of Retail Outlet operations and the database generated reinforces control and analysis of the outlet performance.

Apart from these initiatives, OMCs seem to have adopted dynamic pricing, automated tools for evaluating the economics of new outlet, data analytics (virtual war room, Big data etc.) to enable intelligent planning and value optimisation of outlets.

Overall, fuel marketing is undergoing a significant transformation driven by deregulation, re-entry of Indian private sector players, potential entry of new foreign players, and changing customer behaviour.

Despite earning one of the world’s lowest marketing margins, OMCs seem to be reforming well in this new marketplace.

The writer is Vice President and Fund Manager, DSP BlackRock Mutual Fund

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