Reforms energise oil & gas stocks

Written by fe Bureau | Mumbai | Updated: Oct 21 2014, 11:27am hrs
Shares of oil & gas sector companies surged on Monday as key reforms announced by the government on Saturday excited the Street.

Public sector upstream and downstream companies rallied anywhere between 5% and 9% on the back of government's decision to hike natural gas price and deregulate diesel.

Analysts deemed the announcement as a pre-cursor to more reforms, especially a clarity on the subsidy-sharing arrangements for PSU oil and gas companies. ONGC and HPCL saw the biggest intra-day jump among energy companies, rallying as much as 8.7%.

Click here for graph

ONGC is expected to be the biggest beneficiary of the hike in gas price to $5.61 per mmbtu, effective November 1. According to Ambit Capital, the new formula, which will also apply to the nomination and pre-NELP blocks, could result in a 15% y-o-y growth in ONGCs FY16 earnings.

While the government adopted a modified version of the Rangarajan Committee formula to arrive at the hike, it also announced a revision in the gas price every six months, starting April 1, 2015.

Click here for graph

As per JPMorgan, ONGC is set to be the direct beneficiary of these reforms, given that every $1 increase in the original price could add 7-8% to its earnings for FY16.

Nonetheless, experts say the hike is not good enough to incentivise production growth. ... the price may not be sufficient to undertake the development of existing deep-water discoveries of ONGC and RIL , said Kotak Institutional Equities (KIE) in a research note.

RIL, meanwhile, dropped nearly 3% in intra-day trade as a lower-than-expected price hike would be applicable for the company only if it wins the ongoing arbitration on cost recovery. In January 2013, the Rangarajan Committee had suggested a base price of $8 per mmbtu for domestically produced natural gas.

While consumers of gas from RILs D1-D3 areas in the D6 block will pay the revised gas price, the difference above the earlier price will be deposited into the gas pool account maintained by GAIL, and its award to RIL and its partners would be dependent upon the outcome of the arbitration and any related legal proceedings, noted JPMorgan.

Buying interest in downstream oil companies soared as deregulated diesel prices could lead to up to a 50% reduction in their FY16 under-recoveries. BPCL, HPCL and IOCL rallied 7-8% intra-day.

The diesel deregulation is perceived as a positive for OMCs as it mitigates future under-recovery risk if crude prices rise again. However, analysts appear cautious on the extent of benefit. Ambit Capital believes that deregulation could boost return on equity of OMCs due to a reduction in interest, while acknowledging that they are trading at a premium to their last five-year average valuations.

KIE argues that 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.

Meanwhile, stocks from power and fertiliser space the consumers of natural gas traded with diverse gains. Companies with large gas-based power plants, including GMR Infra, Torrent Power and Lanco Infratech, closed with flat-to-moderate declines. GVK Power and Infra closed the session at Rs 9.24, down 5.6% after falling as much as 7.6%.

According to Sanjeev Prasad, senior executive director & co-head, KIE, said that on a full-year basis, the impact of hike in natural gas price on fertiliser and power sectors would be about Rs 5,000 crore and Rs 4,500 crore, respectively. For the fertiliser sector, the increase in costs will increase governments subsidy as the cost will not be passed on to consumers.

However, there will be no impact on urea companies as they earn regulated returns. Similarly, while power plants that earn regulated returns will not be impacted, profits of other power plants will decline further.