Energy companies: Reform wheel rolls

Updated: Oct 27 2014, 07:04am hrs
We expect PSU energy companies to moderately benefit from the restart of reforms, with the government announcing (i) the deregulation of diesel prices, (ii) increase in gas prices, (iii) implementation of a modified DBT scheme for LPG subsidy (DBTL) and (iv) a framework to ease monetisation of hydrocarbon discoveries. We expect clarity on subsidy-sharing arrangement in the near term, which will be crucial in determining the sustainable earnings levels for these companies.

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Full deregulation of diesel prices to benefit PSU OMCs, albeit gradually: The government has approved full deregulation of diesel prices allowing it to be determined by market forces at the retail level and refinery gate. PSU OMCs (oil marketing companies) cut diesel prices by R3/litre (excluding taxes) from midnight of October 18, 2014. While we expect OMCs to benefit from the deregulation of diesel prices, we do not share the Streets exuberance on the quantum of benefits from expansion of marketing margins, as we expect private players such as RIL and Essar Oil to compete aggressively, particularly in West India. We note that domestic R&M (refining & marketing) companies benefit meaningfully from selling auto fuels in India at trade-parity prices, which is higher than export realisations due to differential customs duty on auto fuels versus crude and notional freight costs. Hence, we expect the earnings accretion for PSU OMCs from expansion of margins on auto fuels to be rather slow and moderate in the light of potential market-share loss.

New gas pricing formula to benefit PSU upstream companies moderately: The government has approved an increase in domestic gas prices from November 1, by linking them to a modified version of the Rangarajan committee formula, which uses a weighted average of domestic gas prices in Canada, Russia, the UK and the US, based on annual consumption. The government has also kept a provision to allow premium prices for new discoveries in ultra deep-water, deep-water and high-pressure, high-temperature fields; however, the government has not shared much detail on its calculation. We expect PSU upstream companies to benefit moderately from the increase in gas prices to $5.61/m BTU on gross calorific value (GCV) basis from the current $3.78/m BTU ($4.2/m BTU on NCV basis). However, the price may not be sufficient to undertake the development of existing deep-water discoveries of ONGC and RIL. Also, RIL and its partners will continue to realise $4.2/m BTU on sales from D-1 and D-3 discoveries and the differential amount from the new price will be credited to GAILs gas pool account pending a decision on arbitration related to KG D-6 block.

Implementing modified DBTL and policy framework: The government has announced (i) implementation of a modified direct benefit transfer scheme for subsidised LPG across India from January 1, 2015 and (ii) a policy framework for early monetisation of hydrocarbon discoveries. The former may help reduce LPG subsidies, if the government eventually restricts it to low-income households, while the latter will address operational issues and help in swift monetisation of existing and new discoveries.

Clarity on subsidy sharing crucial to earnings: We expect the government to provide clarity on the subsidy-sharing arrangement in the near term, which will be crucial in determining a sustainable earnings level of upstream and downstream PSU companies. We have assumed $60-65/bbl of net crude realisations for OIL and ONGC and R10-20 bn of net under-recoveries for downstream companies.

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