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It’s total confusion out there!

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In my previous blog, I wrote about the confusion in the subsidy burden to be borne by the downstream trio of IOCL, BPCL & HPCL and the Govt. Well, the Govt. has announced that its share of the subsidy burden for FY11 would be Rs 41,000 cr and the upstream sector would have to contribute Rs 25,750 cr towards the total FY11 under recoveries of Rs 77,750 cr. This leaves a net under recovery of Rs 11,000 cr to be borne by the downstream sector.

However, confusion continues to persist in the markets, taking its toll on the stocks in the upstream sector, with ONGC losing 6% whereas OIL India & GAIL were down by 4% on May 17. This plunge was triggered by unconfirmed media reports about a hike in the upstream sector’s share of the subsidy burden from the norm of 33% to 38.5%. Not only would this impact the financials of these companies negatively, it would also renew concerns on the ad-hoc nature of the subsidy sharing mechanism which would result in still lower valuation multiples for these stocks in the long term.

However, latest reports indicate that the Govt. is working on a new & transparent subsidy sharing mechanism for the sector. Amongst the various ideas being suggested, the crude price-linked subsidy mechanism, which was first proposed by ONGC and subsequently included in the Kirit Parikh Commission’s report on petroleum product pricing reform, is also being considered. A clear & transparent subsidy sharing mechanism is precisely the need of the hour as it will dispel uncertainty from the minds of the investors and also remove a part of the valuation discount that is currently embedded into the stock prices. In light of the above, we feel that reports about the upstream sector bearing 38.5% of the under recoveries are without any merit.

Moving to the Q4FY11 results, we feel that the combination of $ 100+ crude oil & $ 8+ Singapore GRMs during the quarter would be beneficial for upstream companies and pure refiners. Accordingly, we remain positive on the upstream sector going forward. If the Govt. comes out with an improved subsidy sharing mechanism, this will lead to a re-rating of the sector as a whole.

Written by Fundamental Side

May 19, 2011 at 3:29 pm

Posted in Oil Market

Tagged with , , , ,

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