Just when things were appearing to get under control, Essar Oil's applecart has received a rude shock. The Supreme Court upholding Gujarat State government's demand for sales tax will necessitate the company to pay 6,300 crore - something it can hardly afford with a stressed out balance sheet.

Essar Oil already is burdened with 21,290 crore of debt, which is 3.1 times its equity at end-September 2011. Several years of delay - the refinery was initially planned in 1999, but became operational only in May 2008 - resulted in cost overruns.

The company's annual capex has always been higher than its cash generated from operations necessitating to borrow continuously.

However, things had started looking better for the company with its phase-I refinery expansion nearing completion and CBM block in Raniganj commencing production. Both these factors will not only boost its turnover, but also margins and improve cash generating capacity of the business.

The numbers Essar Oil published for the past three years since the refinery commissioned appeared promising. In the past four quarters, its gross-refining margin stood consistently above $7 per barrel - second best in the country to RIL.

This optimistic scenario had prompted a number of broking houses to upgrade the company. A research report from Citigroup Global Markets at end-September 2011 had mentioned, "We upgrade Essar Oil to 'Buy' from 'Hold' as its phase-I expansion project is on track for completion by CY11-end and should be a key driver of superior GRMs and profitability, going forward.

Besides a nearly 30% increase in capacity, the expansion would also increase Essar's complexity to 11.8 from 6.1 currently, making it the second-most complex refiner in India after RIL."

However, the higher refinery margins - something untypical for its refinery configuration - were mainly due to its ability to collect sales tax without requiring to deposit with the government. On the other hand, interest burden and forex losses impacted the company's bottomline in a big way.

It is not clear how the company will be able to repay 6,300 crore. Borrowing more would be even more costly and asset sale, if any, may not materialise in a short time. Its plan to file a review petition may do little more than gaining time.
Due to the inordinate delay in commissioning of its project, Essar Oil has also missed on an important commodity cycle of 2007-08 when the refinery margins had shot through the roof. Essar's expansion will now come up at a time when the global economic growth is weakening and the refining industry globally is gearing up for a downtrend.

It is going to take a while for the company to shake off the effects of these new woes.