Will oil cos benefit from fuel price hike?

The government has hiked fuel prices. Susanta Mazumdar of UBS says that the subsidy burden should not be more than Rs 20,000 crore (Rs 200 billion). He adds that Oil and Natural Gas Corp would be a net gainer post fuel price hike.

He further says that Indian Oil Corp will be the biggest beneficiary followed by Hindustan Petroleum and Bharat Petroleum.

Mazumdar says that while IOC is likely to maintain its FY06 earnings, the impact of subsidy burden is uncertain on Gas Authority of India.

Excerpts from CNBC-TV18's exclusive interview with Susanta Mazumdar:

For ONGC, what do yesterday's changes mean and do you now start factoring in a higher subsidy pay out this year and cut the EPS forecast?

We do not have to cut the forecast because if you look at last year, Oil and Natural Gas Corporation paid around Rs 12,600 crore (Rs 126 billion). Compared to last year's $70, ONGC's realisation goes up by $10-12, which means additional profit of almost close to Rs 10,000 crore (Rs 100 billion) at PBT level.

Compared to that they will probably pay another Rs 7000-8000 crore (Rs 70-80 billion) of additional subsidy and another Rs 1600-Rs 1700 crore (Rs 16-17 billion) of additional cess as part of the Budget.

So it roughly matches up. Infact they should still be net gainers from the high oil prices. The exact quantum of upstream subsidy is still being debated but our calculation shows that with this kind of price hike, if they continue to be one third of the gap, the amount should not be more than Rs 20,000 crore (Rs 200 billion).

How about the oil marketing companies? How have read these changes for them?

Instead of going through complex calculations, if we look at net under recovery, last year it was Rs 13500 crore (Rs 135 billion), after taking all the support from oil bonds and upstream companies.

Compared to that the current calculation shows about Rs 12000 crore (Rs 120 billion) of under recovery for this year, which means that on a net basis their earnings number either should be same or should be up, compared to FY06.

Indian Oil Corporation could be the largest beneficiary followed by Bharat Petroleum Corporation and Hindustan Petroleum Corporation. But on a net basis their earnings should be higher or the same compared to last year if oil prices stays at current levels.

What about the refineries, Reliance in particular and the standalone refining companies?

Reliance is a little bit less impacted because if you look at last year only 17 per cent of the total sales were to oil PSUs for which if you cut down the tariff protection from 2 per cent to 1 per cent the impact would not be more than Rs 200 crore (Rs 2 billion).

For the balance figure they are always working on trade parity, it means if the domestic realisation is lower than export then they can always export the product.

But the implementation of trade parity is a little tricky and I do not know how practical it is.

Theoretically for a coastal refinery there is no incentive for selling product at a negative tariff protection of 5 per cent because on crude it is paying 5 per cent duty and on product it is getting zero.

This means that on $70 they have a minor $3.5 protection, which is like 60-70 per cent of refining margins. I do not know if any coastal refinery has got incentive to sell the product in the domestic market with that kind of negative tariff protection. It is a very misguided logic and I do not know how it will be in implemented.

In terms of Reliance without trade parity on the lower tariff cut, they are impacted by not more than Rs 200 crore (Rs 2 billion). On the retail side they can obviously match with PSU oil prices for diesel and gas, and to that extent they are negative or under recovery will be reduced.

Are you changing your call on any of these stocks like ONGC, Reliance or the three oil-marketing companies?

The impact on Reliance is not that huge and on trade parity Reliance has always opted for exports instead of suffering a negative tariff protection. If that is the way the government wants to implement trade parity, there is no need to change our call at all. But as far as ONGC is concerned we have downgraded the stock at around Rs 1440 level on the concern of higher subsidy as well as other aspects.

Now with the declining prices as well as more clarity on subsidy, which does not seem to be too much of a threat, the stock should be looked at positively. As far as downstream stocks are concerned theoretically they are benefited particularly IOC which has maintained last year's earnings.

Still the positive macro information from the government tackling the higher oil prices in a more systematic manner is still missing. There will always be some kind of trading opportunity in downstream stocks but in a secular perspective or core holding will still take some time.

The Rangarajan Committee made a lot of sensible suggestions except one or two but again the government has implemented what is easy to implement, and for getting all the difficult parts so in that I guess the action is still missing.

How was GAIL impacted? Do you have any reason to cut down its EPS forecast for the full year?

GAIL is a little bit hazy at this point. One can find out the total upstream subsidy but one cannot find out how much will be GAIL's share. Till last year GAIL's share was Rs 600-700 crore (Rs 6-7 billion) and couple of days before finalising their account they said GAIL to have an additional of Rs 300-400 crore (Rs 3-4 billion) without any particular reason.

GAIL's burden is anybody's guess. Today they are paying market driven prices for the raw material, so from that perspective their subsidy should be lower compared to last year's levels.

If that is the case then there is every reason to look at the stock positively but the key concern in this case is what the final tally will be, because for GAIL there is no particular number, which one can put at this stage.

To sum up your position you are saying you probably could be neutral on ONGC, positive for IOC and marginally negative for Reliance?

That is true

Disclaimer: Neither myself, nor my dependent family members nor my employers, UBS Securities India Private Limited have any interest or position in the securities just commented upon. Due to strict Chinese Wall procedures within the group, I am not aware of positions, if any, held by other UBS group concerns.

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