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SECTOR UPDATE
Oil & Gas Finally, the government shows intent to curtail oil subsidies
Key points The petroleum ministry proposes to increase diesel prices by Rs10/litre over a ten-month period; intention good but implementation is politically difficult
As per media reports, the petroleum ministry has proposed a gradual rise in diesel prices, by Rs1/litre every month, over a ten-month period, in order to avoid controversy engendered by steep hikes in infrequent revisions and to curtail the subsidy burden on the government. As per the recent data from the Petroleum Planning and Analysis Cell, the under-recovery on subsidised diesel is Rs9.28/litre, while the current cost of diesel is Rs47.15/litre. Though it might be politically difficult for the government to implement the hike completely, the government is at least making the right noises. We expect a diluted version (lower quantum of an increase in the diesel rates) of the hike in diesel prices to at least get implemented in the coming months.
Impact on OMCs like IOC, HPCL and BPCL: reacted positively; but under-recoveries on kerosene and cooking gas to continue
We believe the proposal of the petroleum ministry to hike the diesel prices by Rs10/litre over a ten-month period will substantially reduce under-recovery on the diesel if the crude price and exchange rate remain at the current levels. If the proposal made by the petroleum ministry is implemented, it will be positive for the oil marketing companies (OMCs) like Indian Oil Corporation (IOC), Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL) in terms of reduction in the working capital requirement and consequently saving on the interest cost of these companies.
Impact on upstream PSUs like ONGC, Oil India and GAIL: lower subsidy burden on upstream PSUs
To make up for the losses incurred by the OMCs like IOC, HPCL and BPCL, upstream public sector undertakings (PSUs) like Oil and Natural Gas Corporation (ONGC), Oil India and GAIL India (GAIL) contribute to the 40% of the total under-recovery. During FY2012, ONGC contributed Rs44,466 crore, Oil India contributed Rs7,352 crore and GAIL contributed Rs3,183 crore to the total under-recovery. Hence, the profitability of these companies is affected to the extent of subsidy payment. However, with the proposal made by the petroleum ministry to increase the diesel prices by Rs1/litre every month over a ten-month period, the under-recovery on diesel (60% of the total under-recovery) will be substantially reduced if the crude prices and exchange rate remain stable at the current levels. Hence, the move is likely to substantially reduce subsidy payment made by ONGC, Oil India and GAIL, and improve their earnings to the extent of saving on the subsidy payment.
Gas New gas price formula recommended; exploration companies to gain
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Rangarajan committee suggests doubling of gas price: According to media reports, Rangarajan committee has recommended a new formula for fixing the price of the domestic natural gas. The panel has recommended a formula based on the weighted average price of natural gas in the North America, Europe and Japan markets and imported liquefied natural gas (LNG) as compared with the present administered price mechanism followed by the government for fixing the price of gas. According to the new formula, the price of domestic gas works out to around $8/million metric British thermal unit (MMBTU) as compared with the current gas price of $4.2/MMBTU for gas produced from the Reliance Industries Ltd (RIL)-operated KG-D6 basin offshore field.
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RIL, ONGC and Oil India are the key beneficiaries: If the new formula for fixing the price of gas is implemented, then the direct beneficiary will be the oil and gas exploration companies like RIL, Oil India and Oil and Natural Gas Corporation (ONGC) as the move will result in an increase in realisation and profitability. In case of RIL, we estimate an increase in gas price to $8/MMBTU from the current $4.2/MMBTU will be earnings per share (EPS) accretive by over 9% on our estimated EPS for FY2014. However, a decline in the gas output could limit the benefit. Meanwhile, the impact of an increase in the gas price is expected to be much higher in case of the public sector undertakings (PSUs) like ONGC and Oil India (EPS accretion of close to 16%).
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User industries like power and fertiliser to have an adverse impact: In case of the power industry space, gas-based power generation companies would have mixed impact on their bottom line as regulated players would have neutral impact (pass on cost hike into tariff) while merchant companies would find it difficult to pass on the cost hike. Companies like NTPC, Gujarat Industries Power Company Ltd (GIPCL), Torrent Power (having Gas Supply Agreement [GSA] and Power Purchase Agreement [PPA]) are likely to have a neutral impact. However, companies like Lanco Infratech, GMR and GVK are likely to be affected on their merchant capacities. If the new formula is implemented, then the cost of power generation would increase by 40-50%. In case of the fertiliser industry, the cost of production would increase by around 20%, which will ultimately increase the subsidy burden on the government (by around Rs8,000-8,500 crore). However, the companies could be affected in terms of increase in the working capital cycle.
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Neutral for gas transmission but GAIL could feel the pinch on petrochemical and LPG businesses: The gas transmission and marketing margins are not linked to the price of gas. Hence, the gas transmission business of GAIL India (GAIL) will not be impacted. However, this could adversely impact the cost and profitability of liquefied petroleum gas (LPG), compressed natural gas (CNG) and petrochemical businesses of GAIL, as gas is the main input for these businesses. Our interaction with the management of GAIL suggests that if the new pricing norm is implemented, then the base cost structure of the entire industry will change. Hence, GAIL would try to pass on the cost (same step expected from its peers too) to a large extent in the CNG and petrochemical businesses. However, passing on the increase in cost to the LPG business would be difficult.
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