Short-term positive, but under-recoveries still huge

Short-term positive, but under-recoveries still huge

The estimated under-recoveries, or loss of revenue for selling fuel below cost price, in 2011-12 (FY12) will reduce to about Rs1.2 trillion from Rs1.7 trillion after the fuel price hikes and tax cuts. Is that good enough for the oil and gas sector?

To answer that, let us consider under-recoveries’ data for the last two fiscal years. Under-recoveries stood at Rs46,000 crore and Rs78,000 crore in FY10 and FY11, respectively. Considering that, the estimated under-recoveries are still higher.

Analysts say the under-recoveries could be lower than Rs1.2 trillion if global oil prices drop a bit from the current levels. Assuming international oil prices moderate slightly to average $97 per barrel for the rest of the fiscal, estimated under-recoveries would come off to less than Rs1 trillion, wrote analysts from Citigroup Global Markets in a note to clients on Monday. Even so, anything around Rs1 trillion is higher compared with the last two fiscal years’ losses.

Exactly a year after the government deregulated petrol prices, the government took some encouraging steps in that direction again on Friday and increased prices of diesel, kerosene and liquefied petroleum gas. The government also made some positive changes in the duty structure—reduction in customs duty and excise duty of products. Needless to say, this offers some respite for oil marketing companies (OMCs) and upstream oil companies.

It’s well known that OMCs sell fuel below market rates—the losses or under-recoveries arising from that are shared by the government, OMCs and upstream firms such as Oil and Natural Gas Corp. Ltd (ONGC), GAIL (India) Ltd and Oil India Ltd (OIL) in an ad hoc manner.

The government’s decision provides some relief for these companies, explaining the jump in share prices of oil companies on Monday. Stocks of OMCs—Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd increased 3-6% on Monday. Shares of ONGC and OIL, too, increased by 4-5.6%.

The government’s move does improve sentiments in the short run for these firms, more so for the upstream companies. Analysts expect net realizations of upstream companies to improve after this move, which augurs well.

For OMCs though, the uncertainty still persists as far as the subsidy-sharing mechanism is concerned. While uncertainty on the subsidy-sharing formula hurts upstream companies as well, downstream companies are more at risk.

Also, analysts expect earnings of OMCs to be under pressure on account of the increase in their borrowings and current higher interest rates. Unless the government follows this up with another round of hikes later in the fiscal, the realization that the under-recoveries are still huge may sooner or later return to plague investors in these stocks.

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