Lanka IOC and Govt’s long-running pricing conflict

By Madhusha Thavapalakumar

Indian Oil Corporation Ltd. (IndianOil) is an Indian government-owned, listed oil and gas company headquartered in New Delhi and is the largest commercial oil company in India.

It has been an interesting couple of weeks for Lanka Indian Oil Corporation PLC (Lanka IOC). First, it raised its fuel prices despite a prolonged run of extremely low global oil prices. Then, certain quarters of the Government urged the public to boycott Lanka IOC. A few days later, the company announced a price reduction back to the previous price point. This 360-degree turn by Lanka IOC has left many questioning IOC’s pricing rationale and strategy as well as the need for the initial price hike.

It all started on 17 May when Lanka IOC, Indian Oil Corporation’s subsidiary in Sri Lanka, increased the price of 92 Octane petrol by Rs. 5 to Rs. 142, while the state-owned Ceylon Petroleum Corporation’s (CPC) oil prices remained the same. Fuel prices being such a sensitive and politicised issue in Sri Lanka, it was no surprise that this price hike came in for heavy criticism not just of Lanka IOC, but also of the Government which had till then refused to lower fuel prices despite the historic lows the oil prices had been hitting the world over. Nevertheless, after much criticism and calls for a boycott from the Government of Sri Lanka (GoSL), Lanka IOC reduced the price of a litre of 92 octane by Rs. 5 on 22 May, bringing it back to its previous level.

Lanka IOC’s decision to increase local oil prices was heavily criticised by politicians in press conferences as well as the general public on social media. On 19 May, former parliamentarian and current member of Sri Lanka Podujana Peramuna (SLPP) Dilan Perera called for a boycott of Lanka IOC fuel, which according to him is “a good way of teaching a lesson to IOC for this ad hoc price increase”. His request was mainly made towards the 6.9 million people who voted for President Gotabaya Rajapaksa at the presidential elections in November last year.

Janatha Vimukthi Peramuna (JVP) parliamentarian Sunil Handunnetti then challenged the Government to terminate its agreement with Lanka IOC. This followed a warning from President Rajapaksa on the 11th anniversary of the end of the Civil War on 19 May that Sri Lanka would not hesitate to withdraw from any international agreements or bodies if the country’s “war heroes” were targeted by those. Hadunnetti questioned why, if the President could withdraw from such powerful multilateral organisations, he could not withdraw from the Lanka IOC agreement.

However, the noise from both camps has subsided since the announcement by Lanka IOC that it would reduce prices back to the earlier price point. Yet, amidst all these boycott and termination talk, The Sunday Morning Business decided to take a look at Lanka IOC’s existence in Sri Lanka.

Enter Sri Lanka

Indian Oil Corporation Ltd. (IndianOil) is an Indian government-owned, listed oil and gas company headquartered in New Delhi and is the largest commercial oil company in India. In addition to its local subsidiaries in Chennai and a number of joint ventures in the power and energy sector, the company’s foreign subsidiaries are present in Sri Lanka, Mauritius, the United Arab Emirates (UAE), Sweden, the US, the Netherlands, and Singapore. 

In May 2018, IndianOil became India’s most profitable state-owned company for the second consecutive year. Its operating income for last year was $ 5.2 billion while the revenue was $ 85 billion. 

IndianOil’s Sri Lankan journey was established on 11 June 2002, when a Memorandum of Understanding (MoU) was signed between then IndianOil Chairman M.S. Ramachandran and then CPC Chairman Daham Wimalasena. Chandrika Bandaranaike Kumaratunga was the President of Sri Lanka at the time the agreement was signed.

As per the MoU, CPC divested 100 retail outlets owned by them in favour of IndianOil and assisted the latter to re-assign these outlets. IndianOil established its footprint in Sri Lanka in the form of Lanka IOC on 28 May 2003, with it commencing operations in Colombo under the patronage of then Indian Petroleum Minister Ram Naik.

Lanka IOC initially invested about Rs. 4 billion for its Sri Lankan operations and took over 100 filling stations that were given to them by CPC, which gradually increased to 150 filling stations in the following year. This was one of the largest investments from India into Sri Lanka at the time. As a massive tax incentive, the agreement entered into with the Board of Investment (BOI) exempted Lanka IOC from Income Tax for a period of 10 years commencing from 14 February 2003.

By the time of signing the MoU with IndianOil, Sri Lanka had already agreed to lease its Trincomalee Oil Tank Farm to IndianOil on a long-term basis.

By the time of signing the MoU with IndianOil, Sri Lanka had already agreed to lease its Trincomalee Oil Tank Farm to IndianOil on a long-term basis. Furthermore, both IndianOil and CPC agreed to operate and use the total existing and future downstream infrastructure on a common user principal basis. This effectively established IndianOil’s involvement in Sri Lanka’s two terminals in Muthurajawela and Katunayake through a joint venture with the CPC. 

Moreover, storage and pipeline facilities of CPC were transferred into one company known as the Ceylon Petroleum Storage Terminals Ltd. (CPSTL), of which Lanka IOC owns a one-third share. The company paid $ 45 million to CPC on 22 January 2004 to obtain one-third ownership.

Nevertheless, this MoU allowing to end the monopoly played by CPC in the petroleum sector of the country is somewhat contrary to the decision of establishing CPC in 1961 to end the domination of multinationals such as Caltex, Mobil, and Shell in the affairs of petroleum imports in Sri Lanka. Lanka IOC’s entry into the country effectively ended over 40 years of monopoly played by CPC. Lanka IOC opened a headquarters office at the World Trade Center (WTC) in Colombo and began its operations.

Listing and subsidy 

By the end of the second year in Sri Lanka, Lanka IOC was operating 170 retail outlets commanding a 27% market share. Its oil terminal in Trincomalee at that time was Sri Lanka’s largest petroleum storage facility.

According to Lanka IOC’s Annual Report 2004/05, its sales turnover during the year was Rs. 2.75 billion while net profit was Rs. 1.9 billion. In 2003/04, the company’s operating profit was Rs. 427 million.

To broad base its activities, Lanka IOC launched an Initial Public Offering (IPO) in Sri Lanka during the year, which was oversubscribed 11.6 times. Naresh Kumar Nayyar was the Chairman of Lanka IOC during this period. On 22 December 2004, it was quoted at the Colombo Stock Exchange (CSE).

At the end of FY 2005/06, Lanka IOC operated 160 petrol and diesel stations in Sri Lanka, commanding a market share of 22%, a drop compared to the previous FY. As a result, Lanka IOC recorded an operating loss of Rs. 6.6 billion during this period, compared to Rs. 1.9 billion net profit a year ago. According to the annual report, Lanka IOC incurred under-recoveries due to non-realisation of subsidy from the GoSL. This severely constrained the otherwise good performance of Lanka IOC and resulted in a drop in market share and outlets. IndianOil was working on vigorously obtaining early the pending subsidy claims during the year with the GoSL.

The subsidy receivable from the GoSL consisted of the subsidy claimed by the company from GoSL as compensation for the loss arising from the price differential suffered by Lanka IOC due to price revisions not being carried out by the GoSL as per the pricing formula entered into by Lanka IOC, CPC, and the Secretary to the Treasury. The total subsidy receivable from GoSL amounted to Rs. 3.3 billion, representing the claims from January 2004 to March 2006.

The long-pending issue of subsidy payment by the GoSL to Lanka IOC was settled after protracted negotiations during FY 2006/07. This resulted in the reduction in loss of Lanka IOC for this FY and an increase in retained earnings. As a result, Lanka IOC made an operating profit of Rs. 438 million during FY 2006/07 and this increased to Rs. 2.2 billion by the end of the following FY 2007/08.

In November 2007, Lanka IOC managed to commission a lube blending plant in Trincomalee and in March 2008 started bunker operations at the Colombo Port. Lanka IOC also began bitumen sales in January 2010. 

First decade

In 2012, Lanka IOC completed 10 years in Sri Lanka. In these first 10 years of operations, it registered a revenue growth of over 46 times, besides consistent growth in petro product sales, according to reports.

In 2011/12, Lanka IOC expanded the company-owned outlets to 105 in addition to 52 franchise outlets.

Lanka IOC managed to add bunker operations to its business in 2009 and bitumen business in 2010, and this made them a key bitumen player in Sri Lanka by the end of 10 years. Within this period, Lanka IOC was listed as the number one company among the listed companies based on turnover in the listing compiled by LMD (Lanka Monthly Digest).

In 2011/12, Lanka IOC commissioned five more outlets on the Anuradhapura-Kandy Road, in Bibile, Buttala, Mannar, and on the Vavuniya-Mannar Road, and this expanded the company-owned outlets to 105 in addition to 52 franchise outlets. To meet the international Euro III norms, Lanka IOC commenced importing Hi-Octane petrol during this period. Lanka IOC was the first company to import and market Hi-Octane petrol meeting international Euro III specifications in Sri Lanka.

In 2011/12, the company earned foreign exchange amounting to $ 118.6 million, driven by the exportation of Servo lubricants to neighbouring markets. Lanka IOC lubricants had a local market share of 16% by March 2012. In 2011/12, it recorded an operating profit of Rs. 1.9 billion compared to Rs. 769.8 million in 2010/11. During this time, Makrand Nene was the Chairman of Lanka IOC and he left the company in 2013.

Lanka IOC’s turnover for FY 2012/13 grew sharply by 24%, in large part due to the growth in sales of LP 90, Lanka Auto Diesel (LAD), and the company’s bunkering operations. With Lanka IOC’s efforts to aggressively pursue the regional markets in the Maldives and Nepal, yielding positive results during the year, lubricant exports more than doubled in 2012/13 as compared to the previous year.

As a key supplier of bitumen, Lanka IOC‘s bitumen segment enjoyed unprecedented success, with volumes growing by more than 20% for the year under review. A long-term agreement was signed with Matrix Bharat for supplies of bunker fuels for one year effective June 2012. The company’s operating profit increased to Rs. 2.8 billion in 2012/13, compared to Rs. 1.9 billion the previous year. 

An excellent year

In 2013-14, Lanka IOC continued to retain its 50% market share in the area of bitumen and even recorded a volume growth of 3.2%. With the CPC having finally increased their diesel selling price in line with Lanka IOC in February 2013, the latter’s retail sales of diesel grew by 41% in quantity and 46% in value in FY 2013/14. 

Fuel products continued to be their highest profit centre, garnering 75% of the total profit and accounting for 73% of the total turnover. Sales of petrol grew by 3% in 2013/14. In 2013/14, Lanka IOC also partnered with Laugfs Holdings Ltd. to sell petrol and its Servo range of lubricants at three of their LPG stations.

Lanka IOC expanded to 167 outlets in Sri Lanka during this period. Furthermore, it replaced an archaic jetty pipeline for receipt of petrol and diesel with the latest technology in China Bay. An additional jetty pipeline for receipt of low sulphur diesel (LSD) was constructed and a storage tank was modified to store LSD.

In this financial year, Lanka IOC opened 10 new outlets and installed additional dispensing units in 19 petrol sheds. The operating profit during this period shot up by over 100% to Rs. 5.7 billion compared to the previous FY. 

Stock market joy and taxation woes

The highest-ever share price (Rs. 68.30 per share) of Lanka IOC was traded on the CSE during FY 2014/15 and the company was also assigned the highest credit rating (AAA rating) by Lanka Rating Agency (associate of CRISIL India).

Lanka IOC was ranked the second biggest listed company in Sri Lanka in terms of turnover by LMD for the year 2013/14

Lanka IOC was ranked the second biggest listed company in Sri Lanka in terms of turnover by LMD for the year 2013/14 and was ranked ninth amongst the top 25 best companies in Sri Lanka in FY 2013/14 by Business Today.

In auto fuels, Lanka IOC registered a growth in both petrol by 2% and diesel by 15%, with significant growth in XtraPremium 95 octane by 15% and Lanka Super Diesel by 28%. In bunkering, there was a growth of 24% in sales volume during 2014/15 while in lubricant there was an overall growth of 11% during the fiscal year. Lanka IOC signed a high sea sale (HSS) agreement with BOI for overseas product trading and Indrajith Bose was the Chairman of Lanka IOC during this period.

Operating profit fell down to Rs. 2 billion during this period, lower than the previous two FYs. As reported by the then Chairman, this has been mainly due to the taxation by the Sri Lankan Government.

Lanka IOC commissioned 20 new retail outlets, the highest-ever outlet openings in a single year in FY 2015/16, and commenced exclusive bunkering operations at the Trincomalee Port from June 2015 and commissioned storage of bunker fuels at its Trincomalee Terminal in February 2016.

As the annual report of the Lanka IOC noted, the GoSL imposed “Super Gains Tax” during this period year with retrospective effect and this resulted in a cash outflow of Rs. 1.44 billion for Lanka IOC. However, in order to regain investor confidence, the GoSL promised that this would be a once-off tax and would not be imposed again.

B.S. Canth was the Chairman of Lanka IOC during this period and was there until 2017. The operating profit for FY 2015/16 stood at Rs. 2.5 billion, a growth of Rs. 500 million compared to previous year.

200 sheds and 15 years

As Lanka IOC surpassed the 200-outlet mark, its operating profit too increased to reach Rs. 3.1 billion during FY 2016/17. Meanwhile, Lanka IOC was awarded Winner of National Business of Excellence Awards 2016 in the Trading Category by the National Chamber of Commerce of Sri Lanka (NCCSL) and was ranked amongst the “Top 30 Best Companies in Sri Lanka” in 2015/16 by Business Today.

Lanka IOC commenced bunkering operations from its Trincomalee Terminal during the year and achieved all-time high sales of 12,070 MT in the month of March 2017 from its Trincomalee Terminal. Lanka IOC also ventured into the new business segment of petrochemicals during the year.

The company commenced lube exports to Qatar during FY 2017/18, considering potential growth in the area. Bunkering sales doubled from Rs. 9 billion to Rs. 18 billion and lubes sales increased by 19% during the year. Nevertheless, the operating loss during this period was Rs. 1.3 billion, the reason being the increase in domestic selling prices of petrol and diesel was commensurate with the steep uptrend witnessed in international oil prices, which in turn led to high cost of procurement of these products, as then Chairman Ranjan Kumar Mohapatra noted. As per the latest data from Lanka IOC, operating profit for the six months ended on 31 September 2019 was Rs. 420.1 million compared to Rs. 979 million last year.

Sri Lanka-India

The relationship has grown in strength over the past few months under the Gotabaya Rajapaksa presidency

Diplomatic relationship between India and Sri Lanka has somewhat been strong in terms of politics, economics, and trade mainly due to India being the closest country to Sri Lanka as well as due to cultural interaction between the two countries. Both countries entered into the India-Sri Lanka Free Trade Agreement (ISFTA) in March 2000.

According to Sri Lankan Customs, bilateral trade in 2018 amounted to $ 4.93 billion. Exports from India to Sri Lanka in 2018 were $ 4.16 billion, while exports from Sri Lanka to India were $ 767 million.

Apart from Lanka IOC, many Indian companies have expanded their foreign operations to Sri Lanka and this includes prominent companies, food chains, hospitals, and banks such as Indian Overseas Bank and Axis Bank. 

The relationship has grown in strength over the past few months under the Gotabaya Rajapaksa presidency, along with the potential relationship that China – India’s greatest economic rival – could build with Sri Lanka in the absence of India.

Oil prices and government policy

The Sunday Morning Business learnt that Lanka IOC was not a fan of the fuel price formula that was introduced in 2018 by the Maithripala Sirisena Government, as at many occasions, speaking to us, Lanka IOC officials noted that fuel prices were not being revised according to any scientific methods under this formula and complained that certain local price increases were not enough when compared to the global oil price increase.

Nevertheless, when the formula was in effect, there were occasions when Lanka IOC managed to make a profit along with several quarters where they ended with losses. 

Amidst the virtual shutdown of the global economy, global oil prices hit record lows. However, Sri Lanka’s fuel prices remained the same. To prevent excessive profits being made by Lanka IOC, which would also dry up Sri Lankan reserves with the foreign exchange flowing out of the country, the Government increased duty on petroleum imports to Sri Lanka with effect from 13 March.