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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

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Suspense on under recovery sharing continues

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Q3FY11 witnessed the spectacle of the PSU OMCs (IOCL, BPCL, HPCL) postponing announcement of their quarterly results since the Govt. was taking its time in declaring its share of the gross under recovery burden for that quarter. As things stand now, our estimated gross under recovery for Q4FY11 is ~ Rs 31 bn, which is almost double the gross under recovery figure of ~ Rs 15.8 bn for Q3FY11. The sheer amount of the subsidy burden makes this quarter’s results particularly interesting!

The prevalent under recovery sharing pattern entails the upstream sector (ONGC, OIL India, GAIL) to bear 33% of the subsidy, the Govt. to bear 50% of the subsidy and the remaining 17% to be borne by the OMCs. However, due to the meteoric rise of crude during Jan – Mar 2011 and no revision in retail prices of petrol, diesel, kerosene & LPG, the under recoveries have ballooned to ~ Rs 31 bn.

There is a concern that the upstream sector, which benefits from rising crude prices, may be asked to bear a higher share of the subsidy. Such a move, if implemented, would be negative for the entire upstream sector. Moreover, it may result in very poor investor response to the upcoming FPO of ONGC. A higher subsidy burden would be particularly negative for GAIL as it is not an oil exploration company like ONGC & OIL India, and hence, doesn’t benefit from rising crude prices. Hence, while high crude prices and higher subsidy burden roughly balance each other out for ONGC and OIL India, it is not so for GAIL as it has no upside but only downside in such a scenario.

To assuage investor concerns on this front, the Petroleum Ministry has time and again insisted that it would not increase the burden on the upstream sector beyond 33% of the gross under recovery. Meanwhile, enough hints have been dropped about raising petrol and diesel prices after the state assembly elections conclude, as per our expectations. However, this will impact FY12 under recoveries, and not Q4FY11 under recoveries. We expect the Govt. to bear upto 55% of the subsidy burden so that the OMCs can report a minimum ROCE of 12%. This episode only serves to highlight the continued dependence of the OMCs on the Govt.

From the desk of Deepak Darisi

Written by Fundamental Side

April 29, 2011 at 2:16 pm

Posted in Fundamental Side

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