Full reform implementation could lift industry profits by more than 50% in two years
The Indian government seems to be on a roll in executing various reforms in the nation’s oil industry. Even if half its strategy works, industry profitability would still improve. In our view, full reform implementation could lift industry profits by more than 50% in two years and lower the fiscal deficit by 68 bps. In our base case, we assume a 20% profit rise. We upgrade ONGC and HPCL to overweight and GAIL to equal-weight. BPCL remains our top pick because of its E&P hedge.
Diesel accounts for the majority of the fuel subsidy: Diesel accounts for 54% of India’s overall petroleum subsidy. It is categorised into two sections: (i) Bulk consumers—accounting for 18% of volumes; (ii) Retail consumers - accounting for 82% of volumes.
The government decontrolled the bulk diesel selling price on January 18. Since then, the price increased by 25%, marking to market losses and even providing marketing margins for the operators. Approximately 8% of sales volumes for BPCL and HPCL come from bulk diesel. Lowering diesel volumes has lowered overall subsidy by 9%, and this should increase industry profitability by almost 10%. This is equivalent to raising prices by R2 per litre overall in diesel.
The oil companies have also raised the pretax retail price of diesel by R0.45 per litre (post-tax by over R0.5 per litre ) across the country. OMCs (oil and marketing companies) can do small diesel price hikes on a regular basis. We understand this would be without the intervention of the Cabinet, and thus a lot timelier. Our discussions with various industry players also suggest that the intention is to raise prices on a monthly/timely basis over 24 months to nullify/reduce the entire diesel subsidy. We project that every hike of R1/litre in diesel prices has the following effects: (i) It lowers subsidy by R70 billion and fiscal deficit by 0.04%, (ii) It increases ONGC’s earnings by 5%, GAIL’s by 3%, BPCL’s by 5%, and HPCL’s by 7%.
Further downside to subsidy is possible: Earlier in the Budget 2011, the