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Re-strategizing enables base oil procurers to benefit from tax changes in the Indian market

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By: Priyanka Mani
Senior Research Analyst, Basic Chemicals

calender06 Sep 2017

Abstract

1    Introduction

India, the world’s third largest lubricant market, is expected to make a global impact with the changes happening in the Indian market. While the consumption is around 4 million tons of base oils/lubricants annually, only 40 percent of the production happens within India. Growing automotive and industrial segment in the country has led to increased demand for base oils and lubricants.

Globally, base oil is an oversupplied market with the capacity far exceeding the demand. However, India imports more than 60 percent of its base oil needs from Asia Pacific, Middle East and the U.S. During 2016, India imported around 1.8 million tons of base oil for manufacturing lubricants and other products. The wave of reforms such as the fast track implementation of GST, advancing the BS-VI implementation and Make In India scheme are expected to change the synergy operations of both the producers as well suppliers. Import pattern is expected to change in the years to come and the major factors contributing to the changes are:

The demand for lubricants in India is expected to grow at a CAGR of 4-5 percent until 2020 and it has started attracting the energy companies of all sizes. In the back drop of envisaged robust growth, base oil segment in India is expected to attract more investments from global oil majors such as Shell, Repsol and Exxon.

Since India is moving directly to BS VI emission norms from BS IV, this would prompt major hardware changes from the OEMs to cater to the new emission category, accompanied by significant improvement in fuel quality. Lubricants and base oils will have an important role to play in this.

With significant trade, Group I plant closures, a shift to Group II and III base oils, increase in capacities, technological changes and tax innovations taking place in the region, this market is poised to play a key role in shaping the future of the global base oil and lubricant market.

India is one of the fastest growing and dynamic base oil and lube markets, while the Middle East is fast becoming a regional hub for good quality base oil supplies and Africa is evolving and emerging into a prominent market offering tremendous opportunities to the industry’s refiners, suppliers, and blenders in the region.

This white paper will provide a comprehensive overview of the region’s markets including the latest trends in terms of:

  1. Regulations and innovations in automotive industry
  2. Major drivers such as crude oil and its impact due to increasing import dependency and increasing industrial activities
  3. Competitive landscape
  4. Demonization and its impact on logistics (updates and labor cost in India)
  5. Demand and supply information due to major changes in tax regimes and FDAs

This paper will also address in detail the opportunities and challenges for lubricant buyers in India.

India leap-frogging into BS-VI

On Feb 19, 2016 India surprised the whole automobile and allied sector by announcing the implementation of BS-VI emission standard full three years ahead of schedule by April 2020 bypassing BS-V. This is an attempt to align the Indian emission standard in line with European regulations for all classes of vehicles and to meet Paris accord agreement for reduction of emission by 30 percent. This Bharat stage VI implementation is expected to have far reaching impact and incorporate substantial changes to the existing Bharat stage III and stage IV emission standards.

In India, 53 percent of lubricant sales account for automobiles and 70 percent of the sales are from diesel-based lubricants which are projected for a 7-10 percent growth until 2020.

The sales of automobiles are expected to have a robust growth of 7-8 percent in India. This in turn is expected to keep a steady demand for base oil from automobile sector in near future. Along with BS-VI implementation, it is also planned to implement fuel consumption standard in two phases, with Phase I in 2017 and Phase II in 2022. These changes are expected to have far reaching implication on lubricants industry, since the engine manufacturers have already exhausted almost all tweaks on engines that would reduce the emissions. Therefore, processing of exhaust gas is the only option left to comply with the standards and the processing is directly affected by the type of lubricants used. Therefore, current lubricants need to be replaced with more advanced types with new formulations and processing.

MNC lubricant manufacturers with operations in developed countries that have already implemented emission norms such as BS-VI are in an advantageous position since the product is already available in their portfolio. Hence, this has already led to increase in demand for group II and III based lubricants in the developing countries. With the implementation of BS VI reform, India’s group II and III base oil demand is expected to go up attracting more imports in the coming years.

GST reforms

Implementation of GST is expected to improve the ease of doing business, due to the uniform taxation regime across the country. This is also expected to bring local manufacturers on par with its global competitors and incentivize companies to produce domestically. The ease of doing business is one of the key thrust areas of the government. With the implementation of GST, it is expected to enhance the same. It will also help in attracting more foreign direct investment and position India as one of the favoured and preferred destination for investments.

Currently petroleum products except crude oil, natural gas, ATF, petrol and diesel are brought under the purview of GST. Base oil is to attract a GST of 18 percent and this is expected to bring down the production cost of lubricants considerably from $40 to $25 for domestic manufacturers. Therefore, with emission norms looming large on the horizon and GST being implemented, lubricant providers are expected to revamp the strategy. Moreover, with the implementation of GST, the operating cost has come down drastically in lubricant business because goods movement will be faster due to lesser paper work and no need for more storage locations thereby reducing logistics cost.

Make in India

During the last phase of economic growth, manufacturing sector in India was left alone without any potential investment in the base oil sector. The Make in India plan was devised to generate employment in secondary and tertiary sectors and transform India into a manufacturing hub which would attract investments in base oil segment. The Government of India has introduced many sector-specific policies to attract more foreign and domestic investment to boost local manufacturing. Some of the government incentives to encourage Make in India plan are:

  • Reduction of corporate tax to 25 percent to companies below INR5 crore (MSMEs) to make them competitive and shift to company format. This is the step towards reduction of corporate taxes as promised by the government
  • Deduction up to 115 percent for plants and machinery exceeding INR25 crore and separate incentive for companies deploying advanced manufacturing technology and niche products
  • Separate incentives for carrying out research and development that would enhance the production
  • Deduction up to 150 percent of the expenditure incurred for skill development projects

With these changes, the Make in India initiative is expected to provide positive impetus to foster the growth of the manufacturing sector. Growth in the manufacturing segment has boosted the demand for industrial lubricants in the Indian market. Industrial lubricant demand stood at 0.8 MMT in 2016 and it is expected to increase by 1.3MMT until 2020.

Demonetization

Last year, the Indian government announced the ban on currency notes in the denomination of 500 and 1000 that constitutes about 85 percent of the legal tender in circulation. The main objective of the demonetization was to dismantle the cash-centric black markets, fight corruption and remove counterfeit notes.

However, the demonetization had only a short-term effect lasting for two to three quarters. Generally, lube business is divided in to two categories -- direct and indirect. Direct is for large consumers and all them are done only through cashless mode. The indirect category which is reliant on cash transactions was hit during the demonetization period.  

Currently, with normalcy in currency circulation, the off-take of lube and base oil has reached pre-demonetization levels.

Impact of the changes and policies

The cascade of reforms and regulations during the past one year will have a significant impact on the Indian base oil market and the industry structure is expected to change as below:

Base oil structure in India

Impact of BS VI on base oils

  • India’s ambition to align itself with developed nations in terms of emission standard made itself to advance the implementation of BS-VI standard
  • More stringent BS-VI standard is expected to demand higher standard lube oil of group II and group III. While this will depend on imports, it is expected to reduce the demand of group I oil that is produced locally for lube application. Therefore this group I oil is expected to be available for other applications
  • Large MNCs that have operations globally are expected to have an edge over NOCs to cater to the lube oil market due to their technology advantage
  • The unorganised sector which holds around 30% is expected to shrink rapidly due to constraint in the availability technology to produce lubes meeting BS-VI

Conclusion

GST is expected to have much larger impact than any other factor in base oil market.

Currently, base oil is placed under 18 percent bracket of GST, which is almost 10 percent lesser than the earlier taxation range of around 26-28 percent.

What should base oils and lubricant buyers look for?

GST brings in uniform taxation regime across the state, thereby reducing the need for companies to maintain depots at different states. The focus can now be on making big investments at appropriate places taking advantage in terms of logistics, operating cost and Make in India scheme.

  • Lubricant producers and blenders are expected to churn the portfolio of their products based on the region and local requirements
  • To gear up for BS VI emission norms, the lubricant producers are expected to partner with automobile manufacturers as OEM suppliers and accordingly optimize their portfolio of products to cater to both new and old engine lubricants
  • Moreover, high quality base oils for modern engines are expected to be sourced only through imports, especially from the Middle East and the U.S. in the near future
  • Currently around 30 percent share of automotive lubricants is under unorganized sector mainly supplied through local workshop. However, implementation of BS-VI is expected to phase out this sector in a timely manner due to the need of appropriate lubricant for BS-VI engines
  • Unorganized sector that has thrived without any taxes, might find it difficult to continue as GST has better tax trail and compliance methods
  • Items such as crude oil, natural gas, diesel, petrol and ATF have been kept outside the purview of GST. This is expected to increase the operating cost of the refiners and there by the overall production cost of base oil by Indian refiners. Therefore, serious base oil importers can look for Middle East and the U.S. market for imports where they can look for competitive prices and assured supply

Small volume (2000-20000Mt/year) and medium volume buyers in India (20000-50000 Mt/year):

  • Sourcing from direct refiners (IOCL, BPCL, HPCL, Reliance) is recommended as large volume buyers will start sourcing from MNCs such as Shell
  • Single sourcing model recommended. As buyers have to pay only GST to source from any location within India, they can consolidate their spend with one supplier. State- wise tax eradication is expected to bring advantage for small volume buyers in the region

Large volume buyers (more than 50000 MT)

  • Sourcing from private players is recommended: Due to regulatory compliances players such as shell, Rosneft are directly producing base oils/lubricants which meet the regulatory compliance.  Hence, large volume buyers can source from these players from any region within India
  • Multi sourcing model is recommended: 0.8MMT of capacity addition is expected to come online by 2020. This will leave more options for large volume buyers and they can follow multi-sourcing model to eliminate supply risk and regulatory compliance products

Indian refiners are expected to upgrade their refining system and produce more regulated base oils post 2020. However, this change will only happen if the GST imposed on base oils turns positive for refiners within Indian market.

NOCs will be in trouble if GST is not amended…!

NOCs are the main refiners of India as they produce diesel, ATF, gasoline along with base oil. Crude oil, natural gas, diesel, ATF and gasoline are not bought under GST net and current taxation regime is expected to continue.

Therefore, for producing non-GST products such as diesel, gasoline and ATF, they use services that come under GST. This is expected to lead to complex dual taxation and they will not be able to claim tax credit. This is also expected to increase the working capital of the NOCs and operating costs and higher compliance-related efforts.

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