Case Analysis Madras Refineries Limited

Group 1
B V Vishwanath (P16004), Kartik Gupta (P16020), Prasanna Dharkar (P16016), Rishabh Jain
(P16021), Shikhar Bharadwaj (P16009)

Case Analysis: Madras Refineries Limited

Madras Refineries Limited produces lube based stock and refines crude oil into
petroleum products and sulphur for its only customer Indian Oil Corporation Limited.
Challenges faced by refinery industry

1. There are some risks associated in maintaining low crude oil inventory. A slight
fluctuation in supply side of crude oil can have major impact on refinery throughput. Refineries
cannot operate below a certain throughput level, below which they have to shut down.
Considering the high demand for petroleum products the opportunity costs associated in such
situations is high.
2. On the other hand maintaining large crude oil inventory is not advisable because of high
costs and the volatility in crude oil prices.
3. There would problem in accommodating additional stock when a refinery maintains
optimal inventory.
4. There is always a danger of effective storage capacity being reduced by 10 percent due
to sludge and other reasons. MRL has been able to minimize this loss by frequent stirring of
crude oil and draining the tanks periodically.
5. The whole process of production and planning should be dynamic and flexible to
accommodate any projected or unforeseen circumstances which might lead to shortage in
supply.
6. The usual problems of interruptions in plant operations due to failures are always looming.
In addition to it, there is also planned shutdown of plants for overhaul once in two to three
years. These shutdowns may last for 30 to 45 days during which period other plants have to
cater to the demand which was hitherto catered to by the shut-down plant.
7. The demand for different finished products is variable over the year and hence the product
mix has to be altered accordingly often resulting in production of low profitable products.

Background

Madras Refinery Limited was commissioned in 1969 to produce lube base stocks and
refine crude into an array of petroleum products and Sulphur. The refinery has 13 process

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plants and each has a specific function to purify, to rearrange the , molecular structure, or to
crack the molecules to make desired products. The refinery produces light distillates (LPG,
Motor Spirit, Naphtha), middle distillates (Aviation Turbine Fuel, Superior Kerosene, High
Speed Diesel, and Light Diesel Oil), lube-base stocks, Asphalt, Furnace Oil, and Sulphur.

MRL submits a proposed annual production plan for the ensuing production year which
includes various items like crude throughput for the year, mix of crude oil supply, month wise
range of product wise production targets and maintenance shutdown schedules. This plan is
approved by the Oil Coordination Committee. This approved plan becomes basis for operation
of refinery. OCC in its monthly crude planning meeting indicates the crude allocation for the
ensuing month in terms of the name of oil tanker ship, the quantity of crude allocated and the
expected time of arrival at the relevant port. MRL then monitors the movement of its supply
tankers and adjusts its own operations.

Maintenance of inventory again has its own concerns. Low level of inventory would affect
operations as crude throughput would have to be reduced. The opportunity cost of this would
be high leading to unprofitable scenario which may even lead to shut down. High level of
inventory can create storage problems and lead to high demurrage charges. The finished
products are lifted by IOCL, and product distribution is done by IOCL, BPCL and HPCL.

The retention price per tonne of crude throughput for each refinery by adding the delivered cost
of crude per tonne, the average refining cost per tonne, the return on working capital and net
fixed assets per tonne of throughput. Also, the difference between the ex-refinery price and the
retention price is settles through the all India pool account. The govt. is now looking for
maintaining a mandatory reserve of 45 days of crude stock, and mandatory stocks will be
maintained on a separate account which cant be used for routine operations.

Performance Assessment

Exhibit 1 shows moderately Healthy Current Ratio throughout. It also shows that in
1980-81 debt is very limited, but it has increased to 1.01 in 1981-82 due to debt for expansion,
so liquidity issues may arise. Net margin of 1% has increased to 3% recently. This seems
reasonable in this highly capital-intensive industry in which they are operating. Asset turnover
ratio and return on asset is very less. Finished goods Inventory turnover is better than industry
standards.

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Madras Refineries limited (MRL) maintained optimum levels of inventory with the help of
various measures. MRL has improved the storage capacity by preventing dead stock by means
of forestalling sludge formation. By changing product changes, MRL is achieving inter product
stability. MRL ensured zero shut down losses due to reduced throughput with continuous
running of the plant. MRL ensured continuous supply of output even during unexpected
intermissions in plant operations. With optimum scheduling of tanker, MRL ensured no
demurrage charges are incurred because of waiting of tanker for non-availability of enough
space in storage tank.

This shows that MRL maintained consistency between strategy and operations. But, MRL was
not involved in strategic decision making which were regulated by the oil corporation
committee (OCC). So, MRL fits into the 3rd stage of Wheelwright and Hayes model.

Following are the risks associated with low inventory for MRL-

Crude oil throughput could be reduced, if the throughput reduces below 60% then the
refinery cannot function.
Opportunity cost associated with plant shutdown and cost of shutting down and
restarting.
Tanker scheduling will become very critical with low inventory model.
MRL had periodic inventory model for updating crude oil inventory. Inventory
planning and ordering was done one month in advance. Table 1 supports the same.

Table 1: Crude Oil Stock

180
170
160
150
140
130
120
'000 Tones

110
100
90
80
70
60
50
40
30
20
10
0

Date

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Factors leading to this performance

Low Inventory, less money stuck in working capital

Cost Plus Revenue Model

Fluctuating price of Crude Oil

Capacity expansion and Strategic reserve

Return on assets is already low at around 1-2%, so capacity expansion will further
have an impact on this. Strategic reserve is a mandatory reserve of 45 days of crude stock.
Given that crude imports are impacted by global political and economic climate, a strategic
reserve helps in insulating the country from future shortages of crude oil. It is said that this
mandatory stock will be maintained on a separate account and cannot be used to routine
operations without government sanction. But it does provide a buffer to MRL in case
uncertainties on crude supply persist for a long time.

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Exhibit 1-

BALANCE SHEET RATIOS: Stability (Staying

Power)
1 Current 1980-81 1981-82
Current Assets 49,567 42,742
1.03 1.05
Current Liabilities 48,254 40,871
2 Debt-to-Worth
Total Liabilities 178 2,932
0.06 1.01
Net Worth 2,832 2,907

INCOME STATEMENT RATIOS: Profitability (Earning

Power)
3 Net Margin
Net Profit Before Tax 438 1,561
1.29% 3.22%
Sales 33,914 48,547

ASSET MANAGEMENT RATIOS: Overall Efficiency Ratios

4 Sales-to-Assets
Sales 60,444 73,281
1.18 1.57
Total Assets 51,265 46,711
5 Return on Assets
Net Profit Before Tax 706 1,174
1.38% 2.51%
Total Assets 51,265 46,711
6 Return on Investment
Net Profit Before Tax 706 1,174
24.93% 40.39%
Net Worth 2,832 2,907

ASSET MANAGEMENT RATIOS: Working Capital Cycle

Ratios
7 Inventory Turnover
Sales 60,444 73,281
31.30 30.41
Inventory 1,931 2,410
8 Inventory Turn-Days
360 360 360
11.50 11.84
Inventory Turnover 31.30 30.41
9 Accounts Receivable Turnover
Sales 60,444 73,281
4.81 11.77
Accounts Receivable 12,573 6,228

10 Accounts Receivable Turn-Days

360 360 360
74.88 30.60
Accts. Rec. Turnover 4.81 11.77

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