The country’s biggest explorer, ONGC, which shelled out the highest ever subsidy bill of R56,384 crore last fiscal year, may get some relief this financial year, as crude oil prices have dropped by more than a half and government targets to put in place a new subsidy sharing mechanism.
In the last fiscal, the Maharatna PSU sold every barrel of crude oil for $106.72. However, it has to bear a subsidy of $65.75 per barrel to compensate state-owned oil marketing companies, leading to a net realisation of just $40.97 a barrel.
“Due to the considerable reduction in international oil prices, coupled with the deregulation of diesel prices by the government, a significant reduction is expected in the total under-recoveries. Accordingly, the government is already mulling a plan of reducing the subsidy burden for upstream companies, and therefore the sliding oil prices may not affect us. The relief that the government is reaping through the falling oil prices is expected to result in a relief for us”, Dinesh K Sarraf, CMD, ONGC, told FE.
Since 2003-04, upstream oil companies, including ONGC, are sharing under-recoveries of public sector oil marketing companies (OMCs) wherein, ONGC’s share of under-recoveries is passed on to refineries/OMCs by extending discounts on the sale price of crude oil, LPG (domestic) and PDS kerosene. As a result, the net retention prices (post-discount price) of ONGC are far below the international prices of crude oil.
In order to bring clarity on subsidy sharing by upstream companies, the petroleum ministry is believed to be working towards putting in place a slab-wise mechanism. Upstream players such as ONGC, Oil India and GAIL (India) need not share any subsidy burden if the average crude price hovers below $60 a barrel. In case the crude prices range between $60 and $100 a barrel, firms could share 85% of the under-recoveries and 90% in case the crude price crosses $100/barrel.
“If it (the new susbidy sharing mechanism) is implemented, it would be significantly positive for upstream companies such as ONGC, Oil India and GAIL, as it assures a minimum $60 per barrel of net realisation against $44-48 per barrel net realisation in the last couple of years,” said Dhaval Joshi, research analyst at Emkay Global Financial Services.
Joshi said full implementation of direct benefit transfer for LPG (DBTL) will further reduce under recovery on LPG, and if crude stays at about 70-80 a barrel, then the subsidy burden would be significantly lower for the upstream companies, going ahead.
“Moreover, we believe divestment of ONGC also gets through successfully as investors would get clarity on the sharing mechanism, which is the biggest concern on upstream companies valuation. We maintain our positive bias on ONGC and OIL India,” said Joshi.
Brent crude fell below $58 a barrel on Tuesday after the International Energy Agency (IEA) warned that oil prices may decline as stocks continue to increase this year. Brent crude slipped 66 cents to $57.68 by Tuesday afternoon, ending a three-day rally. The benchmark gained more than 9% last week, its biggest weekly rise since February 2011.
“In view of the significant reduction in the total under-recoveries of oil marketing companies and keeping in view the current level of crude prices, ONGC expects that its share of under-recoveries in Q3 FY15 and onwards shall be reviewed and reduced considerably. Thus, our net realisations may improve and we don’t foresee further downsides to our cash reserves. Further, any gas price increase would be an upside for us”, said Sarraf.
The subsidy burden of the last few fiscals has consumed a large part of ONGC’s cash reserves, built up over the years. Over the past decade, the PSU explorer had de-leveraged the balance sheet and stood up as almost a zero-debt company. An upstream company needs a strong internal cash position to develop its assets, especially for capital-intensive deep-water acreages as well as to fund overseas acquisitions.
In line with the trend of the last few years, ONGC’s cash reserves depleted by another 24% to around R10,000 crore by the end of FY14 from the level a year ago. This, despite the company squeezing capital spending for the year by about 15% from the planned R35,000 crore; just R3,200 crore from the reserves were used for exploration/production expenditure. The reduction in the cash position was also due to an outgo of R4,000 crore to convert some unfunded liabilities—in relation to leave encashment and post-retirement benefits to employees—into funded liabilities. ONGC’s cash reserves stood at a record R25,000 crore at the end of FY11.