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| Shorting PSU refiners could be lucrative | | Whether the market improves or not, they are burdened with other issues |
| Devangshu Datta / New Delhi Jan 22, 2012, 00:44 IST |
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Financial analysts do a lot of sensitivity analysis. They attempt to find numeric answers to questions such as: If the dollar-rupee rate swings by plus/minus Rs 1/$, how much difference does it make to the energy sector?
There will rarely be agreement on the numbers. Too many variables are involved; every study will have its own assumptions. However, there is consensus about trends: A drop in the rupee's value lead to an additional energy subsidy bill. The policy of successive Indian governments has made things progressively worse for the domestic energy sector. India imports 80 per cent of its oil and gas. Since the prices of those commodities are highly correlated, the import bill always jumps when prices are high.
Energy consumption has a strong correlation with economic growth. Given sustained demand from India and China, there will never be a prolonged fall in the prices of these commodities until significant alternative energy sources are established.
Turmoil across the Middle East and North Africa has led to the fear of supply disruptions. This has kept oil and gas prices higher than justified by demand during a global slowdown. Fears about an impending embargo against Iran could push prices even higher.
So India's policy-makers have to live with the fact that the economy will have to cope with an energy import bill that gets ever-larger. They can slow this growth rate down by aggressive exploration and production; by encouraging efficiency up and down the energy value chain; pushing on alternatives like solar, hydel, wind, etc. But the energy import bill will inevitably get larger.
The pressure on external balance of payments is dealt with, to a certain extent, by India;s possession of excess refining capacity. India exports a fairly large quantity of refined products. In part, those exports arise because private domestic refiners don't find it viable to sell their products at Indian retail prices. So they sell abroad at market rates.
Domestically, retail prices of key products such as diesel, kerosene, gas are held well below economically viable level. This means a growing subsidy bill if international crude and gas prices rise, or the rupee weakens.
However energy commodities are also taxed, by the Centre as well as by States. So the energy policy recovers large sums as tax revenues, while doling out large sums as subsidies as well. Most years, the tax revenues far exceed the subsidy bill. The Centre has a formula that means the PSUs it controls have to absorb one-third of the subsidy burden. However, it shares 32 per cent of its tax revenues with the states. The states don't share revenues.
Given this complex process, the balance sheets of refining and marketing PSUs such as Indian Oil, HPCL, BPCL, etc., have been destroyed by the subsidy burden. Upstream producers such as ONGC and OIL are in better shape because their prices are linked to global rates. So, although they share a larger subsidy burden when prices are high, they also receive more revenue.
In the current fiscal, the Centre's subsidy bill will be larger than the tax revenues it generates from the sector. It would make total sense to decontrol prices (reducing the subsidy if not eliminating it) and cut taxes as well.
However, during 2012-13, the government will be unwilling to decontrol diesel, kerosene, etc., due to a series of assembly elections. It has already refused permission to PSUs (in its capacity as the majority shareholder) for petrol price hikes due to the same reasons. ONGC, OIL and GAIL could get hit with a larger subsidy burden as a result. If the rupee weakens further, or crude prices spurt, things will get even worse.
For private refiners, margins are likely to get thinner if only because of capacity additions and also because Japanese refining capacity, which was under-par in 2011, will get back online. So this isn’t a rosy picture for them either.
In the circumstances, there is only one “Buy”. Cairn India is slated to increase production and should receive higher prices, while remaining exempt from subsidy. Reliance Industries (RIL) is a special case. Production from KGD6 won't ramp up till 2014 at the least. Refining margins may be thin. But RIL has quantities of cash on the balance sheet and fingers in many other pies. So it cannot be assessed purely as an energy play.
What is most appetising is that the big PSU refiners-marketers are listed in the derivatives segment. If the market continues to be bearish, they will fall further than the overall market. If the market recovers, they will be counter-cyclical and fall anyway. That reads like a series of lucrative shorts.
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