DSIJ Mindshare

Petroleum reforms set the right course for companies

At last government has bit the bullet and fully deregulated the much anticipated diesel prices that will surely help the government in taming fiscal deficit even below the target of 4.1% in the current fiscal year. In fact it is mooted as the biggest reform of recent times as it will help to plug the ever widening oil subsidy bill which stands at Rs 85500 crore (government share including previous year arrears) for 2014 and budgeted at Rs. 63400 crore for current fiscal year.

Also there couldn’t be an opportune time than this when crude prices are declining and already corrected by around 25% during 2014. It is because of this window that even after decontrol of diesel prices, prices went down by Rs. 3.37 per litre. Also as Brent crude dropped to 4 years low to $83 per barrel and Goldman Sachs slashing the 2015 forecast to less than $80 per barrel, it is certainly a kind of windfall for the government, which was under pressure regarding oil subsidy and ever increasing fiscal deficit since last 4-5 years.

As soon as the government announced total decontrol of diesel prices, scrip of oil marketing companies like IOC, BPCL and HPCL ballooned to their 52 weeks high, to levels never seen before. Importantly, UPA government has initiated the process of partial decontrol of diesel in January 2013 by putting in place a mechanism of 50 paisa/litre increase per month on diesel and prices have matched the market price in September 2014. Upstream companies like ONGC and Oil India also got a kind of booster dose with this announcement as they have to share the oil subsidy burden along with government, putting their finances in disarray.

In fact during 2014 ONGC had shared an oil subsidy of whopping Rs 56383 crore in the form of discounts to OMCs. What is more disturbing is that ONGC has alone paid subsidy of more than Rs 2.72 lakh crore during the last 10 years, denting its profitability in a big way and even forcing it to withdraw money from its cash reserves for the operational expenses.

Decontrol: What it means for marketing companies

First and foremost beneficiary of diesel price decontrol are the State-run oil marketing companies as they have to first sell subsidized diesel to the consumers and this under recovery will be compensated by the government and upstream companies afterwards in the form of cash and subsidy discounts. If we take into account the total under recovery on account of subsidised diesel, LPG and Kerosene for 2014 then it ballooned to around Rs 1.40 lakh crore, out of which Rs 70772 crore was shouldered by the government and the rest Rs 67021 crore shared by upstream companies. In addition to this Rs 2076 crore was absorbed by OMCs, hitting them below the belt.

“If you see diesel share in this under recovery stands at whopping Rs 63000 crore during previous fiscal, which will now be saved benefitting both petroleum companies and government. “Clearly next year oil subsidy would be much lower, helping the government to tame crucial fiscal deficit that is budgeted at 4.1%,” commented a petroleum ministry official.

Considering this, the government is quite hopeful that the current fiscal’s subsidy bill would be considerably lower than the previous year of Rs. 1.40 lakh crore and vague estimates shows that it will be around Rs. 85000 crore this year. During the first half itself under recovery stands at around Rs 49900 crore, out of which diesel subsidy accounts for Rs 11900 crore while kerosene and LPG subsidy remained at Rs14500 and 23500 crore respectively.

Now with deregulation in diesel coming and direct cash transfer of LPG subsidy taking shape, OMCs are expected to save great amount cost in terms of interest burden that they have to incur to finance under recoveries as well as under recovery absorption. Important to note that government usually gives cash subsidy to OMCs in tranches but to finance under recovery in between OMCs have to resort to funding involving interest cost. Already this benefit has impacted the stock prices of IOC, BPCL and HPCL as they are now trading at their 52 week high and this gain will continue as crude is expected to remain low in the medium term also.

Upstream companies will gain but gas price reform is a dampener

Though due to deregulation of diesel prices upstream companies like ONGC and Oil India also set to gain as they have to shoulder much lower burden of under recovery, Gas price reform introduced by the NDA government may proved to be a dampener as increased price of $ 5.61 per mmBtu from $4.2 per mmBtu is much below the earlier suggested price of $8.4 per mmBtu by the UPA government. Government officials are explaining that this increased price effective from November 1, would be a win-win for both exploration companies as well as consumer. CCEA has taken both into account before deciding about this crucial matter.

Even at $5.61 per mmBtu price, companies like ONGC and Oil India set to gain by a huge margin. ONGC sources are of the opinion that company will gain Rs 4000 crore for every dollar increase in price, so with this increase company is slated to gain more than Rs 6000 crore annually. On the other hand this increased price of gas will not apply to Reliance Industries’ KG D1 and D3 fields as there is an arbitration process going on between government and RIL over the production from the fields. The differential amount between the old price and new price will be deposited into a gas pool account till the matter will be decided. “This price increase will certainly benefit the exploration sectors as foreign investors are waiting for some clarity over the pricing issue.

Now with this increase more investment would come into Indian oil and gas exploration sector as government is gearing up for next round of NELP auction,” informs the ministry official. “In all probability government wants to change the revenues sharing mechanism from the current cost plus production sharing contract (PSC) to revenue sharing model,” he added.

Considering this upstream companies like ONGC, OIL India and big refiners like RIL and Essar Oil are set to gain in coming times, if not now and with more clarity coming about the quantum of gain they incur, their stock price will certainly showcase the gain. Also as government has put a window of reviewing the Gas price every six months, it will again benefit the exploration companies. Considering that investors can now hold on to these scrips as reforms ball has been set rolling in the sector.

Private operators will enter into retailing!

There is another angle to this deregulation of diesel. It leads to an end to the era of subsidized fuel and will in turn lead to re entry of private operators into oil marketing space. Already companies like Reliance Industries, Essar Oil and Shell are mulling their retail foray and waiting for some clarity from the government. “They want some crystal clear position of the government over the complete decontrol of petrol and diesel as they are treading consciously this time over any kind of cap on price of petrol and diesel in the matter of sudden spurt in the price of crude as happened in 2004 by UPA government,” quips government official. If this clarity comes that decontrolled regime would stay even if crude price go haywire them surely Indian oil marketing space will see enormous activity as happened in post 2002 scenario, when Vajpayee Government decontrolled the oil marketing space.

This certainly a big booster for the industry as private players will bring in more competition into the space. In the past also due to their aggressive pricing and better services private players were able to corner 15-16% market share before going for an abrupt closedown due to the reintroduction of subsidized fuel regime in 2004, which made their petrol and diesel unviable in comparison to subsidized fuels of government controlled OMCs. This may happen again, which clearly signals a big threat for the OMCs and they should improve their services in the marketing space. But overall consumer set to gain due to competition.

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