ONGC over a barrel if crude price soars

State explorer ONGC Ltd could spend about 50% of its turnover to finance the petroleum subsidy bill in 2009-10. The company, India?s largest public sector oil firm by market cap, gave away more than 44% of its turnover in 2008-09 as price discount on crude sold to public sector oil marketing companies.

Last year, the average price of crude, for the Indian basket, was $83.58 a barrel. But now, with the price threatening to touch $100 a barrel, ONGC will end up paying 50% of its turnover as its share of the oil subsidy. The company now shares about a third of the total fuel subsidy bill.

This means, unless the current subsidy sharing formula is tweaked, ONGC will effectively cut back its investment programme for oil exploration by a half.

?India?s energy security lies in balancing energy affordability with right incentives for investments to make energy accessible to all,? Sanjay Kaul, an energy sector analyst at Deloitte told FE.

What vexes ONGC and to a lesser extent Oil India?which together set apart 46% of their turnover as price discount on diesel and petrol sold to oil marketers?is that they will never know what their subsidy bill if crude hits $100 a barrel. The reason: there is no pre-set, transparent methodology in place to calculate the subsidy burden, nor is there any correlation between the average price realisation and the subsidy burden, says a senior ONGC official.

?We have no idea what formula is used by the oil marketing companies to calculate their under-recoveries. The company is informed about its subsidy burden at the end of each quarter by the petroleum planning & analysis cell under the petroleum ministry,? the official told FE.

For instance, ONGC?s gross price realisation, or the money it earns on each barrel of crude it produces, was $85.54 during 2007-08. It marginally rose to $86.15 a barrel in 2008.09. ?But during the same period, the subsidy discount paid by ONGC increased by $5.81 per barrel,? the official said. Effectively the company was losing more money per barrel, despite the higher price realisation.

The official said it was necessary to develop a pre-determined, transparent formula to calculate the subsidy burden. In the current system, it is impossible to plan long-term investment allocations, as the subsidy part is determined by the petroleum ministry.

Energy experts like Ajay Arora, partner, transaction advisory services, Ernst & Young told FE that if international oil prices breach the $100-mark, the government will have no option but to raise the prices of petrol and diesel. ?So long as oil remains below $100 per barrel, the government might not feel an emergency to raise the retail prices of petroleum products. However, if it crosses that level, the government will have to take a call.?

However, for fear of a political backlash, the government would avoid sharp price hikes and continue to issue oil bonds to compensate the marketing companies for under-recoveries.

The current subsidy regime divides the responsibility between the upstream companies like ONGC and the downstream ones like IOC, directly and through oil bonds. The share can vary each year, though the burden for upstream companies has been about 32% of the total bill in 2008-09 and 33% in 2007-08.

The total subsidy pressure on the oil sector was Rs 1,03,292 crore for 2008-09, a rise 34 % from the year earlier, despite a huge meltdown in crude prices last year. The burden of the subsidy on the turnover of ONGC and OIL combined was Rs. 32,900 crore in 2008-09, almost 46%.

?Any company which is diverting 46 % of its turnover (not net profit) elsewhere is bound to forego required investment. In this case, if ONGC and OIL forego investments in technology or buying assets overseas, it will be a great setback to the country?s energy security,? Kaul said.

IOC and the other marketing firms have oil bonds, with sovereign guarantee, to show in their balance-sheets. ?But here too, since these bonds cannot be counted as verifiable liquid assets by the banks, it affects their tradability in secondary bond markets. All these result in serious working capital issues,? Kaul added.