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| Rising crude an overhang on OMCs |
| Naresh Kothari / Aug 12, 2010, 01:01 IST |
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Crude oil recently touched $80/bbl, spurred primarily by better–than-expected economic indicators in Europe and consequent depreciation of US Dollar. At this level, domestic oil marketing companies (OMCs) may have to bear an under-recovery burden of about Rs 54,000 crore in 2010-11. This is comparable to the gross under-recovery of Rs 46,000 crore in 2009-10. Petrol/diesel and LPG/kerosene accounted for 31 per cent and 69 per cent of this, respectively.
On June 26, 2010, the empowered group of ministers, after taking the Kirit Parikh Committee report into consideration, decided to completely deregulate petrol and increase prices of diesel by Rs 2 a litre, of LPG by Rs 35 a cylinder, and of kerosene by Rs 6 a litre. This, though a definitely bold move, was still insufficient to alleviate issues related to under-recoveries in the sector. Petrol and diesel are currently pegged at $78/bbl and $73/bbl of WTI crude, respectively, already leading to under-recoveries in the system at current prices.
While consumer prices of petrol will likely be pegged to market rates of crude oil and, hence, lead to zero under-recoveries; diesel decontrol may be difficult. Impact of increase in diesel prices on inflation and upcoming elections in some key states including Bihar (November 2010) and West Bengal, Tamil Nadu, Kerala and Assam (May 2011) may hold the government’s hand from deregulating diesel.
The under-recoveries for 2010-11 are estimated at Rs 54,000 crore (crude price of $80/bbl, USD/INR at Rs 46). With every $1/bbl rise in crude oil price after this, under-recoveries will swell by Rs 3,000 crore. This may be further aggravated by: (a) depreciation of the INR (Indian Rupee)—under-recoveries rise by Rs 5,500 crore for every unit of INR depreciation; and (b) huge growth in diesel demand (recent growth rate of about 8 per cent compared to about 5 per cent earlier). For, 2010-11 uncertainty on sharing of the under-recovery still prevails. While it may be best to assume that upstream companies will share around one-third of the total under recoveries (approximate numbers for the last three years), there is still lack of clarity on sharing of the balance two- thirds.
The subsidy sharing uncertainty in the sector will remain an overhang on OMC stocks (IOCL, BPCL, and HPCL), while upstream companies like ONGC, OIL, and GAIL will be less impacted due to increase in break-even prices of petrol and diesel. Investors could consider investing in the gas sector which has a better growth visibility with GAIL, IGL, and Petronet LNG being top picks. The prospects of Reliance Industries also look good on the back of positive outlook for industry refining margins, although, near-term upsides are likely to remain muted with a cap on KG-D6 gas production for the next 9-12 months.
The author is President, Edelweiss Capital. The views are personal
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