Doing away with deemed duty

The oil refineries in the country can be pressed for even tougher times in FY20. The government seems to be planning to do away with deemed duty on diesel sales, which if implemented will not be taken well by the refining segment.

The deemed duty that currently is at 7.5 percent is being collected by the oil refineries for the specific purpose of capital expenditure for upgrading and expansion of their refining plants. It was levied back in 2002. However, the sole purpose for which the deemed duty is being collected by the refineries has largely remained unfulfilled; and refineries have continued to collect this levy, but their efforts to upgrade their production processes and plants to produce better grade petroleum products has stalled despite extensions in the deadlines multiple times.

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This is not the first time the authorities are considering the scrapping of the deemed duty on HSD sales. However, this time it is reportedly part of the new policy for the sector that is in the works. According to market sources, significant currency devaluation has already taken its toll on the segment’s earnings; the said move will burden the refineries further as this levy has been cushioning their profits. Moreover, the market is of the view that it will further disincentivise the players towards the much needed upgradation that is required of them.

Recall that the downstream oil refining segment had been hit hard when the government changed its course away from furnace oil; And since the local refineries have been largely producing the heavy distillate - which kept fueling the power sector for long - a sudden change in policy of phasing out the furnace oil weighed heavy on the sector’s productivity and volumes. The phasing out of furnace oil is continuing, leaving little choice for the refineries. Rather, medium to light distillate oils that come from further processing like petrol and diesel could help them salvage the dropping efficiency levels. For the same purpose, the domestic refineries were asked to upgrade and install isomerisation plants and Diesel Hydro Desulphurisation (DHDS) units to produce environmentally friendly gasoline from naphtha, and Euro-II complaint diesel, respectively, and many refineries still haven’t completed these projects.

Refineries have abused the benefits of deemed duty. However, phasing it out completely means that they will have another reason to stall upgradation plans. There are also reports suggesting that the government is planning to introduce refinery margins for the oil refiners. How will that work? Is it a compensating move for the removal of deemed duty? There is no clarity on the subject yet. However, what must be known is that refineries earn variable margins based on the costs incurred. The cost is pegged to international benchmarks like crude oil and are vulnerable to exchange rates. Fixing refinery margins would mean taking on more volatility. Is the sector ready to do that?