The government approved on June 25 the deregulation of auto fuels that were subsidised for most of the last five years. Kerosene price was also hiked for the first time since 2002 and so was LPG. Coming on the back of the higher-than-expected administered pricing mechanism (APM) gas price hike, it has been confirmed that the government is finally serious about oil & gas sector reforms. Diesel deregulation and further LPG, kerosene price hikes need to follow and may be done in the second half of 2010-11. In fact, we believe it is unlikely if it’s not done in 2010-11. Oil sector deregulation now looks possible. High oil prices and political compulsions are the risks that could again derail deregulation.
Petrol has been deregulated with a 7% hike. Diesel price is hiked only by 5%. A further hike (6% at current prices) to deregulate diesel is to be made by oil companies in consultation with the petroleum ministry. LPG-kerosene price has been hiked by 11-32% against 32-64% proposed by the Kirit Parekh panel. The price hikes have cut subsidy by Rs 25,300 crore ($5.5 billion).
The expert group proposal of diesel deregulation and further hike in LPG-kerosene may be done in November 2010 after the only state assembly election in FY11. It will be easier if oil price is below $80 per barrel. A strong rupee would also help. Price hikes would likely be difficult in FY12-FY15E, as there are at least five state elections each in these years.
When diesel will be deregulated or how the remaining subsidy will be shared is not clear. If diesel is deregulated and LPG-kerosene hiked further in FY11E, the expert group proposed subsidy sharing implementation will be possible. That would mean no subsidy for refining and marketing companies. We are assuming subsidy of Rs 4,500 crore for refining and marketing companies in FY11E vis-?-vis Rs 6,000 crore earlier. This has boosted our FY11E EPS by 7-17%. We retain Buy on ONGC and OIL with a revised price target of Rs 1,741 and Rs 1,717, respectively. HPCL and IOC have been raised to Buy from Underperform with a price target of Rs 507 and Rs 438 respectively. BPCL has been raised to Neutral from Underperform with a price target of Rs 651.
The deregulation of the Indian oil sector worked well in FY03-04, floundered in FY05 and got derailed in FY06. Deregulation got derailed as political compulsions of a weak government did not allow it to increase domestic price in line with surging international oil price. The present government is stronger. However, even now higher oil price and political compulsions are the main risks to reforms. They could once again derail deregulation.
Even the petroleum ministry release after the EGoM meeting says: ?It has also been decided that in case of a high rise and volatility in international oil prices, the government will suitably intervene in the pricing of petrol and diesel.? Reforms will be easier if oil prices remain weak at $80 per barrel or lower.
?Bank of America Merrill Lynch
